BAJAJ BROKING
September 19, 2024
4 mins read
Equities are an extremely popular way of making an investment worldwide. When you make an equity investment in a company, you end up actually owning it. Hence, you stand to gain and even lose from such investments. Therefore, you should make them wisely. In India, you can buy equity shares of listed companies by just opening a demat account. Over a long period, equities provide the highest return across all asset classes. Hence, almost all investors should have some equities in their portfolios.
When a person starts a business, he invests his own funds into it. These funds are known as equity. If you own equity shares in a company, you are its owner to the extent you hold shares in it. Hence, you will gain if the company performs well and you will lose if it does not. Having explained what an equity investment is, let’s discuss other aspects related to it.
The term “equity” means how much a business owner has invested in his company. In other words, equity stands for how much someone will have to pay to a company’s owner to buy the company from him.
In accounting terms, equity can be calculated by deducting a business’s liabilities from its assets. Let’s discuss it a bit. Assets stand for what a business owns. What a business owns can come from two sources. One, its liabilities. Two, the amount of capital invested in the business by its owner. Hence, when we deduct a business’s liabilities from its assets, we are left with the amount of money invested in that business by its owners (or shareholders), which is known as equity.
Now that we have learnt what an equity investment is, let’s discuss various types of it:
Common Stock: This is the most prominent type of equity shares. Those who hold common stock in a company have a claim on the company’s profits. If a company decides to pay dividends, those dividends are paid to the owners of common stock. Owners of common stock essentially own a company. They also participate in electing the board of directors of a company.
Preferred Stock: The owners of these shares get a preference over those of common stock when it comes to receiving dividends. If a company decides to distribute dividends, it has to first pay dividends to its preference shareholders and only then can it pay to its common shareholders. Similarly, even when a company’s assets are distributed upon its liquidation, it has to first pay to its preference shareholders and then it pays to its common shareholders. However, while common shareholders vote to elect the board of directors, preference shareholders have no voting rights.
Let’s take an example to understand how equity works. Assume that a person called X starts a company. He will have to raise funds to buy assets, which will then be used to make products to be sold in the market.
When it comes to funds for his business, either X can invest his own funds or he can borrow from others. His funds in the business are known as equity, while those of others are known as loans or debt.
So, X starts a company, which manages to do well and become reasonably famous. Now, he wants to raise funds to expand. Either he can sell his stake or take a loan. So far, X was the only equity shareholder of the company. If he sells his stake, he will raise funds, but the company will have more equity shareholders.
A company’s equity shareholders have a claim on its net profit. From their net profits, companies often pay dividends to shareholders. This is one way for such shareholders to earn.
They can also make a profit by selling their stake to an investor at a higher price than they had paid for it.
When you buy shares of a company in the stock market, you’re essentially buying its equity. If you hold equity shares in a firm, you are its owner to the extent you hold shares in the firm. For example, if a firm has 1,000 shares and you hold 100 shares, you own a 10% stake in the firm.
In the stock market, millions of shares of publicly listed companies are traded every day. If a stock has a high volume, it means a significant number of shares are being traded. Therefore, it’s likely that a considerable number of people are buying and selling those shares. In such a case, it’s possible that you will get a fair price for that stock in the market. However, investors don’t always agree that the stock market pays them a fair price for their investments.
This is particularly true for shares with low trading volume. When only a few people buy or sell a share, it’s possible that you won’t get a fair price for it. That said, the c is a great mechanism to find the true value of your equity shares.
If you have equity in a company, you can gain in many ways. One, if the company performs well and is publicly listed, the value of your shares may increase. As a result, you may be able to sell your shares at a higher price than you had paid for them. Hence, you may earn a profit.
Even if the company is not listed, you may be able to sell your stake to a private investor who’s willing to pay you a high amount. Two, you can even earn dividends on your equity investments. However, dividend yields don’t tend to be very high. So, you shouldn’t invest in a company just for dividend yield.
Three, if you own shares in a publicly listed firm, you can sell them anytime you want in the secondary market because such shares typically tend to have high liquidity. Few assets have better liquidity than equity shares.
When you have equity in a company, you actually own it. Hence, if the company doesn’t do well, the value of your investments will most probably decline. This is the greatest risk associated with equity. Therefore, if you want to own equity in a company, you should assess its performance from time to time.
What if you don’t want to assess a company’s performance? In that case, you can still own equity in it by buying the units of a mutual fund that invests in the company. However, in this case, you will have to watch out for the performance of the mutual fund. So, either way, you take a risk by having equity in a company.
If you own shares in a publicly listed company, then the price of those shares will see ups and downs due to movements in the stock market. At times, a company’s stock declines even when it performs well. You can deal with this risk by investing in a company for the long term and not paying excessive attention to daily movements in its stock price.
As a retail shareholder, you should understand how much equity you should own in your portfolio. For this, you can approach a financial expert, who can guide you based on your investment objective.
By and large, all investors should invest in equities, but how much they should invest varies from case to case. If you are still young (less than 40 years old) and want to invest for the long term, you can invest a significant portion of your portfolio in equities. This is because equities are the best performing asset class over a long period of time.
Conversely, if you are 70+ years old and don’t want to invest for the long run, you should invest a low portion of your portfolio in equities. Within equities, you should decide whether you want to invest in large-cap, mid-cap, or small-cap stocks.
Companies with a high capitalisation tend to have a huge scale of operations. Hence, they are more stable than mid- and small-cap companies. Mid- and small-cap companies are smaller in scale and hence show greater volatility in performance.
It’s not tough to understand what an equity investment is. However, it requires skill to find the right companies in which to invest. Hence, when you invest in equity shares through your online demat account, you should be careful because you may end up investing in the wrong companies. To avoid this, you should read financial news extensively, develop an interest in a few industries, and track a few stocks. Over some time, you will be able to find good companies to invest in.
Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.
This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
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In financial terms, equity is the difference between a business’s total assets and total liabilities. It means the amount of funds invested in a business by its owners.
Equity stands for the amount of funds invested in a business by its owners. However, debt stands for the funds lent to a business by lenders.
Common stock and preferred stock are the different types of equity. Common stockholders get to vote to elect the board of directors; however preference shareholders don’t have the right to vote. But, preference shareholders get preference over common shareholders when it comes to the payment of dividends.
When a company’s owner reduces his equity, he sells his stake in the company. For selling his stake, he gets money from other investors. However, post-sale, his equity becomes lesser than earlier. So, his ownership in the company is reduced to an extent.
Equity should feature in the investment portfolio of almost all investors. Over the long run, equity provides the highest returns. However, equity investments can gain or lose value due to the movements in the stock market.
If a company is listed, you can value its equity shares by checking their price in the stock market. If it is not listed, you can deduct its total liabilities from its total assets to find the value of the equity.
In India, if you own listed shares and you sell them within 12 months, you have to pay 15% short-term capital gains tax on the gains made. However, if you sell the same shares after 12 months, you have to pay 12.5% long-term capital gains tax on gains.
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