An investor though not prudently specified has a purpose for making an investment. Based on the objectives, they devise their investment portfolio. These objectives can be short-term or long-term. The risk and return associated with each investment instrument vary. Thus, there is always a need to follow a systematic procedure for the selection of the desired asset like stocks to invest (Selvil, 2015). The aim of this article is to review the main types of investment instruments, types of stocks as an investment instruments, and to review the scenario of the Indian stock market.
An introduction to investment
Investment refers to the decision made by a person by evaluating and creating an opportunity of preserving wealth and earnings. Harry Markowitz, (1952) in his modern portfolio theory stated that investors are people who rationally make their investment decisions. By basing their decision on having the expectation of maximum possible return at a given level of risk, rational investors tend to specify their optimal portfolio. The behaviour of an investor regarding an avenue is dependent on three important aspects:
- The need of the investor from the investment.
- Risk preference of the investor.
- The expected return from the investment.
Thus, in order to make any decision regarding the investment, an investor needs to be clear about their need and the nature of the risk.
Types of investment instruments
Investment instruments are classified on the basis of investor preferences. An investor who wants returns with minimum risk tends to invest in income assets, while investors seeking long-term high returns invest in growth assets.
Generally, assets can be segmented into 4 categories i.e. equities or stocks, bonds, property, and cash (Vanguard, 2014).
Stocks are a source of high returns and high income with the growth of the associated company. Therefore, many investors prefer to preserve their money in the form of stocks. A stock which is more prone to risk tends to create higher income (SEC, 2011). Based on this risk-return trade-off, stocks are majorly classified into three categories i.e.
Income stocks are the form of instrument that helps in balancing the portfolio of an investor against volatility by providing a steady income. These stocks are defensive stocks which remain in existence irrespective of business or market conditions like:
- natural resources,
- real estate investment trust and,
- financial institutions.
With a fixed income portfolio, the yield on income stocks is higher than the guaranteed stock instruments like treasury securities. Like all other equities market fluctuations affect the income earned on these stocks but the intensity of impact is low. Thus, there are fewer chances of price factor appreciation which make it less risky. Some of the companies issuing income stocks are Tesla Motors, AT&T, Walt Disney companies, and Coca-Cola (Cussen, 2019; Kiplinger, 2005; Terzo, 2012; Thune, 2020).
Growth stocks are stocks of companies that have the potential to grow faster than any other company in the market. With the possibility of a major role in the market in future, these companies invest most of their revenues in expansion activities. Investors tend to invest in these stocks due to their past record of good earning rates. Growth stock companies have the potential of creating innovative products, thus they are very popular in the market.
Many the companies in areas of alternative energy, technology, and biotechnology raise growth stocks. As the growth stock performance is dependent on the earnings, small movement or development in the market could make returns on these stocks lower. Hence, they are less stable companies, prone to high risk. Companies raising growth stocks are Amazon and Microsoft (Cussen, 2019; Hoekjan, 2011; Kiplinger, 2005; Terzo, 2012; Thune, 2020).
Value stocks are stocks issued by undervalued companies. These companies are well established and enjoy good financial returns. However, because these stocks trade at a rate below the average market price, they are often undervalued. A stock is regarded as a value stock due to its maturity, poor performance in the past, and less stability. As these stocks are traded in a situation of distress, large investors prefer not to invest in them.
Value stocks thus are cheaply available in the market with the possibility of earning a high return in future. Hence, the average risk is imposed on these stocks. Companies issuing value stocks are TCS, Asian Paints, and Hindustan Unilever (Cussen, 2019; Doukas, Kim, & Pantzalis, 2004; Hoekjan, 2011; Kiplinger, 2005).
Indian stock market overview
India saw its first stock market in 1875 in the form of the Bombay stock exchange (Yadav, 2017). Currently, there are 9 stock exchanges in India:
|Sr. No.||Name of the recognized Stock Exchange||Recognition Valid Up to|
|2||Calcutta Stock Exchange Ltd.||Permanent|
|3||India International Exchange (India INX)||Dec 28, 2020|
|4||Indian Commodity Exchange Limited||Permanent|
|5||Metropolitan Stock Exchange of India Ltd.||Sep 15, 2020|
|6||Multi Commodity Exchange of India Ltd.||Permanent|
|7||National Commodity & Derivatives Exchange Ltd.||Permanent|
|8||National Stock Exchange of India Ltd.||Permanent|
|9||NSE IFSC Ltd.||May 28, 2020|
Among these exchanges, the National Stock Exchange of India is the largest stock exchange followed by BSE Ltd. In India. These stock exchanges list companies from 73 sectors wherein banking, IT, automobile, real estate, metal, media & entertainment, FMCG, power, pharmaceutical, and PSU banks are the major ones (Agrawal, 2018).
Although all three types of stocks are traded in India, Mukherjee, (2019) stated that about 99% of investors in these markets invest in value stocks.
Main concerns of the Indian stock market
With the growing economy, Indian stock exchanges are also growing. However, there is evidence suggesting that people lack knowledge about the way to choose the optimal stock for investment (Government of India, 2011; Shekhar, Jain, Deshpande, & Rai, 2018). Furthermore, similarities in stocks make the classification of different types of stocks complicated. This problem of identification further confuses investors while choosing the appropriate stock for investment.
Past performance of the stock also plays an important role in selecting the optimal stock for investment (Jagongo & Mutswenje, 2014). However, complexity in the procedure of analysing the past performance of stock prevents many people from investing. Thus, considering these three problems i.e. lack of knowledge, difficulty in identification, and past performance analysis; further articles in this study aim to analyse the dynamics of the Indian stock market and formulate a model to forecast the behaviour of different stocks. Thus, further articles of this study would focus on the fulfilment of the objectives:
- To state the method for the identification of stocks.
- To analyse and compare the risk-return trade-off of income, growth, and value stocks.
- To formulate the model for predicting the behaviour of stocks.
Contribution of stock market analysis in making an optimal investment decision
Robert G. Allen once said, “How many millionaires do you know who have become wealthy by investing in saving accounts?”. An optimal choice of investment can make a person a billionaire, but it entails a high risk too. To be on the gaining side of the stock market, it is important to be fully aware of the nature of stocks, and their risk-return trade-offs. Furthermore, for assured returns, it is important to be able to forecast the behaviour of stocks.
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