Understanding Demat
Date Published: February 11, 2022
Basics of the Stock Market
Stock Market broadly refers to a common place where the stock exchanges, the brokers and other market intermediaries come together to facilitate buying and selling of securities for the buyers and sellers. The word Stock Market includes the word Stock and the word Market. ‘Market’ as widely known is a place where the buyers and sellers exchange goods and services for a particular amount of money. While Stock means shares in the company. These shares are issued at a price which can be at par, premium or discount. When a share of a company is sold at its face value it is called at par. When a share is issued at a price higher than its face value it is called premium. When a share is issued at a price lower than its face value it is called at discount.
The definition of a share is in line with its general meaning i.e. it is a part. Therefore, shares are units of equity ownership in the overall capital of the company. A company is formed using its owned capital and borrowed capital, if required. Borrowed capital is in form of long term loan and has a defined period for repayment at a fixed/floating interest rate. The shares on the other hand is a part the company’s own funds and it generates positive return in form of dividend if the company makes profit. If the company suffers a loss, the company may not pay a dividend.
The entire profit earned by a company is not distributed amongst its shareholders. The proportion of profit that a company distributes to its share holders is called dividend payout ratio. So if for example a company earns a profit of Rs. 50 crore on a capital of Rs. 2 core equity shares of Rs. 10 each, the per share profit generated is Rs. 25 and of this, the company may have a dividend payout ratio of 40% which would be Rs.10 per share. The dividend is a recurring income on the investment while capital appreciation depends on the secondary market price and generally happens over a longer period of time.
Capital appreciation is the rise in the price of a share vis-a-vis its investment amount. There are various factors that contribute to the appreciation in the price of a company viz. the business model, future growth potential, profit earning ratios, expansion plans, innovation etc.
The price at which a share trades in the market is its market price while the price at which the company’s shares are offered to general public in an Initial Public Offer is called the issue price. The issue price is the price at which the shares are valued by the promoters to sell their shares in the market. In the Secondary Market, the share price is determined by the demand and supply forces unlike the price of any other commodity.
What is a Demat & Trading Account?
Just like the money that we earn or save is stored in a Savings Bank Account of a Bank, the shares that we hold are stored in a Demat Account with a Depository Participant. The shares that are issued in the primary market through the initial public offer are allotted directly from the Issuer company to the client’s Demat Account. However to buy or sell the stocks that are already listed in the market, the investors require another type of an account called Trading account. The Trading account represents an investor in the share market or secondary market through his registered broker. The buying and selling of shares happens through this account number and it is mapped to the investors Demat account.
The Demat account can be mapped to the client’s trading account using a Power of Attorney which helps the client in making a payin of his securities for sell transactions without any Delivery Instruction Slip (DIS). The shares in Demat account of a client cannot be moved out without the written confirmation from the client in a prescribed format. The POA facilitates the exchange debits in the Demat Account of the investors. However, the POA is only meant for the secondary market related transaction. For any Off-market transfer, from one person’s Demat account to another person’s Demat account, a DIS is mandatory. Recently, the e-DIS facility is also being made available by the Depositories which is a OTP based online/electronic delivery instruction slip.
How to invest in stock/share markets?
In order to invest in the stock market there are two routes, the Primary Market and the Secondary Market. The primary market is where the stock is directly issued by the promoters of the company through an Initial Public Offer. For investing through an IPO only the Demat account is sufficient cause the allotment of shares happens directly in the client account. However the allotment of shares depends upon the number of times the IPO is over subscribed. If the issue has a very encouraging response, then the allotment is based on a lottery method to some applicants while the rest of the applicants get refund of their application money back into the Savings Bank Account registered with their Demat Account.
In the Demat Account, one can only store the equity shares. To sell the shares in the Secondary market a Trading account is compulsorily required. One can sell the shares in a Demat account through an Off Market transaction also to their friends, relatives or other acquaintances having Demat accounts. However, in an off market transaction the counter party risk is borne by the investor. The investor has to search a buyer for his scrip and ensure that he receives payment for the shares transferred by him from his account.
In case of secondary market, the buyers and sellers are not known to each other and the counter party risk is handled by the exchange. If the buyer does not pay the money the seller either gets his shares back or a refund of his sale proceeds. Thus there is complete transparency and no personal biases can affect the quality of transaction in the secondary market as all the transactions are executed by the standard trading practices formulated as per regulatory guidelines.
What is the use of a Demat Account?
Demat account allows investors to hold their investments in securities in an electronic form as opposed to physical form. Hence, it eliminates the risks of forgery, theft, damage or any other kind of loss to shares, which could happen when held in physical form.
When investments are held in demat form, a Depository (such as NSDL) allows consolidated investment and it’s performance reporting, periodically. So, an investor gets a single snapshot reporting for all their investments in demat form.
Demat accounts are mandatory for trading/ holding shares on delivery basis.
Also, for selective kind of investments, such as IPOs, Demat account is mandatory.
Share market investment tips:
a) Decide the objective for investment, such as short term trading or long term investing and an area of investment such as equity, F&O etc.
b) Learn about analysis supporting investments in share markets, based on the above. So, for trading purposes, technical analysis will be useful along with how macro events (like interest rate hike or GDP growth) and firms specific events (like earnings results) affect share prices. Whereas for long term investments, fundamental analysis of firms, sector and macro environment including valuation would be useful. For Futures and Options, learn about techniques for arbitrage trading and other trading strategies with corresponding risk-return payoffs.
c) Learn about operational aspects of investing, such as requirement to open Demat/ Trading accounts, margin requirement for trades, trade settlement mechanism.
d) Do not rely on external unsolicited advice.
e) If unsure about investment, seek out a credible investment advisor registered with SEBI and possibly commit small capital amounts till you get assurance about the advisor’s credibility and trustworthiness.
f) For trading purpose, always use stop-losses and take profits, as a risk control tool. For investing purpose, be clear about your strategy (Buy and Hold or/ and Dynamic asset allocation; in case of latter, have objective reference defined for selling/ buying).