9.11 Ratios & market prices
For better understanding, you need to know certain fundamentals related to the cause of price increase (or rise in demand) for any share. The major factors are:
- The current profits are high compared to its previous year’s profits or the profits of the competitors.
- The future profit earning potential of the company is very high even if the present working does not reveal so.
- The company is heading for a turnaround after years of loss-making operations.
- The industry itself is showing a turnaround. For instance, after years of demand recession, when the rising demand for cement outstripped the supply by the cement companies, the entire cement industry underwent a turnaround. Consequently, all cement companies’ shares shot up.
- When any company announces a rights issue, its share price goes up. The rationale behind this is the fall in average purchase price of the share after getting rights. For instance, say the price of a share (Rs10 face value) is Rs30 when the rights are announced by the company at 1:1 ratio at par. Suppose you purchase 100 shares of that company at Rs30. You will get another 100 shares as rights which will have a face value of Rs10. Thus your total investment in 200 shares will be 30 × 100 + 10 × 100 i.e. Rs4,000. Thus, the average price of each share will be Rs20. Now if the ex-rights price falls from Rs30 to say Rs25, then also you are a gainer because your shares (original plus rights) cost you only Rs20.
- When a company declares a bonus issue its share price shoots up. Here also the same logic applies i.e your average cost of holding shares would fall drastically. In the previous example, if you had got 1:1 bonus instead of rights, you would have got 200 shares at 30 × 100 i.e Rs3,000. So, the average would have been only Rs15 and you have more shares.
- When a sick company is being taken over by a profitable company, the share price of the former rises.
- When two companies undergo merger, the share price of the weaker company goes up. When the RIL and RPL merger was declared, the price of RPL’s shares started climbing.
- When the floating stock (i.e. shares held by the public for trading) of a company is very low, slight transactions can raise or lower the price to a higher extent. A mis-match of demand and supply is the main reason for such price appreciation.
- When speculators buy shares in large chunks (such speculators are called bull operators), the soaring demand raises the price.
- When a change in government policy or any such environmental factor influences the mass sentiment of the investors, the prices of shares flare.