Module for Beginners
Investment Analysis 101
1. What are public limited companies?
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Welcome to module 2 of Smart Money! In this module, we’ll be picking up the pace and touch upon various topics such as understanding industries and businesses, getting to know what SEBI and stockbrokers are and the details of various reports. So, strap your seat belts on and enjoy the ride!
Before we go any further, let’s try to understand what a business actually is. Take your local kirana store owner for instance. What does he do, exactly? He gets certain products directly from the manufacturer or the distributor and sells them to you for a marginal profit. This particular activity can be termed as a business.
What are the different forms of business ownership?
A business can be owned either by a single person or by a group of like-minded people. Let’s take a brief look at the three main categories into which businesses are generally classified according to their ownership..
- Sole proprietorship: When a business is owned by a single individual it is termed as a sole proprietorship. For example, Beauty supply stores, ice cream parlors and perhaps even your local pharmacies are examples of sole proprietorship businesses.
- Partnership: When two or more people come together to own and operate a business, it is termed as a partnership. Accountancy and audit firms are very good examples of partnership businesses.
- Limited liability company: A limited liability company is a corporate entity that is registered and has a separate legal identity. Hindustan Unilever is an example of a limited liability company. A limited liability company can be either a private limited company and public limited company.
What are public limited companies?
A public limited company’s definition is the answer to the question - What are public limited companies? Essentially, public limited companies are corporate entities that are registered under the Indian Companies Act. They have a separate legal identity and are considered to be distinct from their owners.
This effectively means that a public limited company is recognised by law as a separate entity from its owners and can enter into agreements under its own name. While these companies are still owned and run by their owners, they have their own separate set of rules, obligations, regulations and legal rights.
The owners of a public limited company are termed as the ‘shareholders’ or ‘stakeholders’ of the company. The ownership interest of the entity is split into multiple units known as ‘shares’ or ‘equity shares.’ These units of ownership are typically held by multiple individuals or corporations.
Here’s a fun fact. With respect to a public limited company, the minimum number of ‘shareholders’ is 7, which effectively means that there are at least 7 different owners at any point in time. Another interesting thing is that there’s no limit on the maximum number of ‘shareholders’ for a public limited company.
What are the characteristics of public limited companies?
Public limited companies have certain characteristics that distinguish them from other forms of business ownership. Let’s get to know these distinguishing features.
What is limited liability? Limited liability effectively means that the owners of a public limited company cannot be held liable for any of the debts incurred by the entity. The following example will explain things better.
Let’s say that a public limited company defaults on a loan. In such a situation, the lenders can only hold the company accountable for repayment of the loan. In no case can they go after the owners and force them to repay the debts incurred by the company. The owners here are legally protected by law from being personally held accountable. This is not the case with sole proprietorships or partnerships.
With public limited companies, almost everything is transparent and open to public knowledge. Right from their financial statements down to a change in their management composition, the information is accessible to the public.
Transferability of shares
With respect to public limited companies, the shareholders are free to buy and sell the shares to anyone. So, if you hold shares in a public company, you can trade them through the stock market, provided the public limited company is listed on it. Alternatively, you can also sell the shares to a specific individual or an entity outside the market, irrespective of whether the company is listed or not.
What does it mean for you, as an investor, when you invest in a listed public limited company?
When you invest in a public limited company that’s listed in a stock exchange, you automatically become a shareholder of that company. Being a shareholder, gives you a claim on the profits of the company, which may be periodically distributed to all the shareholders in the form of dividends. Additionally, when the company is finally liquidated, you also get to enjoy a residual claim on the net assets after the company sets off all its existing liabilities.
How do you go about investing in the business model of a public company?
You can invest in a public company through the primary market or the secondary market. You’ll recall that we discussed these markets back in module 1, in the lesson on the different types of financial markets.
Investing through the primary market
The primary market is where public companies list their securities for the first time. This can either be in the form of an IPO or an FPO.
- An IPO (Initial Public Offering) is the process through which a company offers its stocks for sale to the public for the first time, when it’s newly listed on the stock exchange.
- An FPO (Follow on Public Offer) is the process by which a company that’s already listed on an exchange issues fresh securities to raise additional capital.
Either way, in both IPOs and FPOs, potential shareholders like you buy the shares directly from the company, through the stock exchange.
Investing through the secondary market
In the secondary market, securities that have already been issued are traded. Existing shareholders may sell them to traders and investors who wish to buy those stocks. A number of financial assets like debentures, bonds, options, commercial papers and treasury bills can also be traded in the secondary market. Here, transactions happen between two different investors and not between an investor and a company, as in the case of a primary market.
Once you’ve invested in a public company, how do you earn from your investment? To put it simply, there are many ways in which you can earn from investing in a business. And that’s just what we’ll be looking at in the next chapter of this module.
A quick recap
- There are different forms of business ownerships: sole proprietorships, partnerships and limited liability companies.
- Public limited companies are corporate entities that are registered under the Indian Companies Act. They have a separate legal identity and are considered to be distinct from their owners.
- The owners of a public limited company are termed as the ‘shareholders’ or ‘stakeholders’ of the company.
- The ownership interest of the entity is split into multiple units known as ‘shares’ or ‘equity shares.’
- These companies have limited liability, which effectively means that the owners of a public limited company cannot be held liable for any of the debts incurred by the entity.
- With public limited companies, almost everything is transparent and open to public knowledge.
- Shareholders of public companies are free to buy and sell the shares to anyone.
- You can invest in a public company through the primary market or the secondary market.
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