Rule 3: Don’t buy shares in closely held companies

Whether a company is widely held or closely held depends upon the number of shareholder it has. In this book, we will draw the line at 5,000 shareholders. Companies with less than 5,000 shareholders will be considered as closely held.

Shares of closely held companies tend to be less active than those of widely held ones since they have a fewer number of shareholders and, thus, a smaller floating stock of shares. Shares of such companies tend to be ignored by the general public. Large institutional investors also tend to avoid closely held companies. As a result their shares do not get sufficient price support, which they would otherwise have got if they had been widely held. Moreover, it is always much easier to manipulate the share prices of a closely held company than those of a widely held one.

Share prices of closely held companies also tend to be more volatile than others. When they rise they rise very fast, and to a very high level. Conversely, when they fall they dose very fast and to a very low level. As a result, it is generally very difficult to buy shares in a closely held company when prices are rising, and very difficult to sell them when prices are falling. Investing in such shares requires a high degree of expertise, knowledge, alertness and quick thinking which take years of active investing to acquire. We would, there fore, strongly urge you to keep away from such shares.

Rule 2: Don’t buy inactive shares

Active shares are those in which transactions take place every day, or almost every day, on the stock exchange. At the other extreme are shares in which transactions take place rarely, if ever. The latter are called inactive shares. In this book, an inactive share has been defined as one which is transacted less than two times a month, or not at all.

The main reason why shares are inactive is because there are no buyers for them. They are mostly shares of companies which are not doing well and whose future prospects appear to be dim. Naturally, nobody wants to buy their shares. As a result, existing shareholders of these companies find it difficult to get rid o their shares, even at very low prices. And, if nobody wants to buy these shares, why should you? Whey should you allow yourself to get such with an investment, which you can’t offload at will, whenever you want to? We wooed strongly advise you to avoid investing in inactive shares.

How does one find out whether a particular share is inactive or not? The simplest way is to regularly scrutinize the stock market quotations which appear in the daily newspapers. If you find that a particular share has not been quoted for a long time, you can presume it is inactive. Some newspapers, like The Financial Express not only indicate the last quoted price of each share, but also the date when it was last transacted. This information fan helps you to confirm whether a particular share is inactive.

Inactive shares can generally be bought at very low prices. This is obvious since such shares generally find no buyers. Inexperienced investors looking for bargains are often attracted to such shares by virtue of their low prices. This is how beginners are normally trapped into making disastrous investments. Beware of such bargains! If you come across a bargain, remember there has to be a catch in it somewhere. It is better to hunt for value, and pay a fair price for it, than to look for such apparent bargains.

Every time you buy a share, you must remember that one day you will want to sell it. If you think you are likely to face difficulty in selling it- don’t buy it! This is a sound investment principle which you should never lose sight of, no matter how cheap or attractive a particular investment may appear to be. Never allow yourself to get caught with illiquid shares. They are only pieces of paper without any value. Shares have value only when they are readily excisable.

Of course, it is possible that a share witch is inactive today could become active tomorrow; just as a share which is active today could become inactive tomorrow. It all depends upon the degree of buying interest in a particular share. If buying interest builds up in a share, it can easily move from the inactive to the active category.

Rule 1: Don’t buy unlisted shares

Three are over 20,000 public limited companies in India, of which only around 7,000 listed on the country’s various stock exchange. The first rule of profitable share investment is to confine your buying to these 7,000 listed companies only.

Stock exchanges do not permit trading in unlisted shares, nor do they permit their registered members, i.e. brokers to deal in unlisted shares. You won’t get the protection of the stock exchange authorities; nor will able to use the services of your stockbroker in handling such transactions. More over, in the absence of stock exchange quotations you wont be able to assess what the market price of an unlisted share should be. All these factors create complication and risk, which you are should avoid investing in shares of unlisted companies.

How does one know whether a share is listed or not ? It’s simple; all shares whose prices are quoted in daily newspaper are listed shares. Unlisted shares are never quoted. Therefore, the fact that a share is quoted means that it must be listed. This is the easiest and surest way of finding out whether a particular share is listed or not.