
Equity shares are a way for companies to raise capital by issuing shares to investors, giving them a stake in the company's ownership and profits. This can be a great way for companies to grow and expand.
Investors who buy equity shares are essentially buying a small part of the company, and in return, they get a claim on a portion of the company's assets and profits. This can be a high-risk, high-reward investment.
As we'll explore in more detail, equity shares can be a great way to diversify your investment portfolio and potentially earn higher returns. However, it's essential to understand the risks involved, including the possibility of losing some or all of your investment.
What Are Equity Shares
Equity shares are a primary vehicle for companies to secure long-term funds, granting investors ownership benefits and substantial voting rights.
Investors with a significant holding of ordinary shares wield considerable influence in various management aspects, contributing to the decision-making processes within the company.
Equity shares can be classified into different types, including ordinary shares, preference equity shares, bonus shares, and rights shares.
Ordinary shares are a primary vehicle for companies to secure long-term funds, granting investors ownership benefits and substantial voting rights.
Preference equity shares are issued with the guarantee of receiving cumulative dividends before ordinary shareholders, but they lack voting and membership rights associated with common shares.
Here are the main characteristics of each type of equity share:
Bonus shares symbolise the capitalisation of excess funds generated through business operations, which can be a great way for companies to reward their shareholders.
Types of Share
Equity shares come in various forms, each with its own unique characteristics and benefits. Ordinary shares are the most common type of equity share, allowing investors to own a part of the company and participate in decision-making processes.
Bonus shares are additional shares distributed to existing shareholders without any additional cost, often resulting from a company's accumulated profits or reserves. This can be a great way for companies to reward their loyal shareholders.
Right shares give existing shareholders the privilege to purchase additional shares before they are offered to the public, allowing them to maintain or increase their ownership in the company. This is often done on a pro-rata basis, ensuring that all shareholders have an equal opportunity to participate.
Sweat equity shares are issued to employees or directors as a form of compensation for their contributions to the company's growth, allowing them to have a stake in the company's success. This can be a powerful tool for retaining key employees and motivating them to work towards the company's goals.
Non-voting shares, on the other hand, do not grant shareholders the right to participate in decision-making processes, but still offer a share in the company's profits. This can be a useful option for companies looking to raise capital without giving up control.
Here's a breakdown of the different types of equity shares:
Features and Benefits
Equity shares offer a range of benefits to investors, making them a popular choice for those looking to grow their investments over time.
One of the key features of equity shares is that they signify ownership in a company, giving shareholders a real stake in the company's success. This means that shareholders have a say in the company's policies and major undertakings through voting rights.
Equity shareholders are entitled to a share of the company's profit in the form of dividends, although the payment of dividends is at the discretion of the company's board of directors.
Equity shares can fluctuate in value based on market conditions, the company's performance, and other economic factors, but this also means that there's a potential for significant gains as share prices increase.
The value of equity shares can fluctuate based on market conditions, the company's performance, and other economic factors, but this also means that there's a potential for significant gains as share prices increase.
Here are some key features of equity shares:
- Ownership stake: Shareholders have a real stake in the company's success.
- Voting rights: Shareholders can influence company decisions through voting rights.
- Dividend income: Shareholders are entitled to a share of the company's profit in the form of dividends.
- Capital gains: The value of equity shares can fluctuate, offering the potential for significant gains.
- Residual claim: In the event of liquidation or winding up, shareholders have a residual claim on the company's assets.
- Limited liability: Shareholders' liability is generally limited to the amount invested in the shares.
- Transferability: Equity shares are traded on stock exchanges, providing liquidity to investors.
Dividend Payments
Dividend payments to equity shareholders are not fixed and can vary based on the performance of the firm and contingent on it meeting certain goals. This means that while equity shareholders are eligible to receive dividend payments, these payments are not guaranteed.
Most companies pay an annual or quarterly or even special one-time dividends based on the total profits made during the year. This can create a sense of stability for investors, but it's essential to remember that companies can choose not to make these payments.
Income earned from dividends is taxable as per the Income Tax Act, 1961. This is an important consideration for investors who rely on dividend income.
Companies can either pay fixed rate, referred to as preferred dividends, or they can pay variable dividends based on the earnings, known as common dividends. This distinction highlights the difference between equity and preference shares.
Companies are not obliged to make these payments by any regulatory guidelines. This means that investors should not count on receiving dividend payments as a certainty.
Here are some key facts to keep in mind about dividend payments:
- Dividend payments can be annual, quarterly, or one-time.
- Dividend income is taxable.
- Companies can choose to pay fixed or variable dividends.
- Companies are not required to make dividend payments.
Irredeemable Shares
Equity shares are a type of investment where the money raised is not refunded to investors during the lifetime of the company.
The money raised from equity shares can be redeemed by selling the shares, but only when the company winds up and the shares are worth something at that time.
Equity shareholders have the lowest priority when it comes to getting back their money, especially if the company fails.
Creditors who lent money to the company get paid back first, and even if some money is left, the holders of preferred stocks get paid next, subject to a maximum amount.
Preferred Stocks
Preferred stocks are a type of investment that offers regular dividends, which are higher than those received by holders of common stocks.
One of the main reasons preferred stocks are called that is because they pay dividends based on a fixed rate, unlike common stocks which pay dividends based on the company's profitability.
Preferred stocks have a par value, which is the face value of the stock, and the dividend is calculated based on this value. For example, if a preferred stock is worth Rs 1,000 and the dividend is 5 percent, the stock must pay Rs 50 as dividend every year.
Unlike common stocks, preferred stocks do not have voting rights, which means that holders of preferred stocks do not have a say in corporate governance.
Preferred stocks can be of different types, including convertible preferred shares, cumulative preferred shares, and redeemable preferred shares.
Here's a comparison of preferred stocks and common stocks:
Preferred stocks are often considered less risky than common stocks, but more risky than bonds. They also offer a fixed income stream through dividends, which can be appealing to risk-averse investors.
Preferred stocks are not likely to increase in value much, even if the company performs well, which means that holders of preferred stocks have fewer chances of making large profits.
In the event of liquidation, preferred shareholders are paid before equity shareholders, which makes them more secure than common stocks.
Investment Risks and Methods
Investing in equity shares can be a bit daunting, especially when it comes to understanding the risks involved. According to Burton Malkeil, there is no sure way of predicting the equity markets, and the Random Walk Theory suggests that beating the market is not mathematically possible.
To mitigate these risks, it's essential to understand the different methods of equity trading prediction. Technical analysis, which involves analyzing past stock behavior, is used by around 10% of trade analysts, including Burton Malkeil. However, fundamental analysis, which looks at real-life indicators of a company's health and value, is a more effective approach, with Malkeil suggesting that internal expectations of growth, dividend payout, and price volatility are key indicators.
While there are various investment methods, including IPOs and stock market purchases, it's crucial to be aware of the risks associated with equity investment. Market fluctuations, economic downturns, and company-specific issues can impact the value of equity shares, with risks including market risk, company-specific risks, liquidity risk, and currency risk.
Risks of Investment
Investors should be aware of the risks associated with equity investment. These risks can significantly impact the value of equity shares.
Market fluctuations can lead to a decline in share prices. Economic conditions, interest rates, and geopolitical events can all contribute to this.
Company-specific issues can also affect the value of equity shares. Poor financial performance or governance issues can lead to a decline in share prices.
Liquidity risk is another consideration for investors. In some cases, trading volumes may be low, making it challenging to buy or sell shares at desired prices.
Currency risk is also a factor for investors in international markets. Fluctuations in exchange rates can impact the returns on equity investments.
Here are some of the key risks associated with equity investment:
- Market risk: The value of equity shares is influenced by market dynamics.
- Company-specific risks: The performance of a company, its management decisions, and industry trends can affect the value of its shares.
- Liquidity risk: There can be instances where trading volumes are low, making it challenging to buy or sell shares at desired prices.
- Currency risk: Fluctuations in exchange rates can impact the returns on equity investments.
Market Prediction Risks
Beating the market is not an actual mathematical possibility, as the Random Walk Theory by Burton Malkeil (1973) states.
There are many scientific studies that prove the lack of predictability in equity markets, including those by Ball and Brown, Fama, Jensen, Goyal and Welch, and Pontiff.
The idea of predicting effective return predictors is also flawed, as shown by studies on Rosenberg, Reid and Lanstein, and Campbell and Shiller.
It's worth noting that Jegadeesh and Titman have also contributed to the understanding of the unpredictability of equity markets.
The consensus among researchers is that there is no sure way of beating the market, and that's a crucial fact to keep in mind when making investment decisions.
Methods of Trading Prediction
Investing in the stock market can be a daunting task, but understanding the methods of trading prediction can help you make informed decisions. There are two primary methods for explaining and predicting equity value: technical and fundamental analysis.
Technical analysis is based on analyzing past stock behavior to forecast future reactions. It looks for patterns like "head and shoulders" or "wedges" or "triangles" to indicate market behavior.
Around 10% of trade analysts use technical analysis, according to Burton Malkeil. This method can be useful for identifying trends and making predictions, but it's essential to understand its limitations.
Fundamental analysis, on the other hand, examines a company's real-life indicators of health and value. Malkeil suggests that effective indicators include internal expectations of growth, dividend payout, and history of price volatility.
Different Investment Methods
Investors can choose from two primary methods to buy and sell equity shares: IPO (Initial Public Offering) and Stock Market Purchase. IPOs make shares accessible to the public for the first time, allowing anyone to become a shareholder of a firm.
To participate in an IPO, investors can apply for shares via their net banking accounts or bid on the company's shares on stock markets. This process enables investors to engage with the company's initial public offering and potentially earn listing gains.
Stock Market Purchase, on the other hand, allows investors to buy and sell equity shares throughout the year. To do this, they need to create a Demat and Trading account connected to their bank account.
Here are the key differences between IPO and Stock Market Purchase:
- IPO: Buy shares directly from the company during its initial public offering.
- Stock Market Purchase: Buy and sell shares on the stock exchange throughout the year.
Investors should be aware that both methods involve risks, and it's essential to exercise caution and seek expert financial advice when making investment decisions.
Frequently Asked Questions
What is meant by 20% equity?
A 20% equity stake represents ownership of 20% of a company's profits, assets, and sale proceeds. This means you'd receive 20% of the company's value if it were sold, such as $40 million if sold for $200 million.
Is equity profit or loss?
Equity is neither profit nor loss, but rather the company's net worth, calculated as assets minus debt. Understanding equity is key to grasping how effectively a company's assets are being used to generate profits.
Sources
- https://www.angelone.in/knowledge-center/share-market/equity-shares-meaning-features-advantages
- https://www.bajajfinserv.in/what-are-equity-shares
- https://www.lexisnexis.co.uk/legal/glossary/equity-shares
- https://www.toppr.com/guides/business-studies/sources-of-business-finance/equity-shares-and-preference-shares/
- https://www.gripinvest.in/blog/equity-shares-101-guide
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