Equity shares are one of the widest used methods of investing in the stock market. Many investors try their luck with equity shares to gain significantly high returns that stocks usually offer. A lot of companies source capital from investors in order to finance a number of business operations. Equity shares are investment tools issued to public investors in order to fund the expansion of a business. In this blog we will take a look at what equity shares are and all you need to know about them. Let’s begin!
Equity Shares Definition
Stocks, also known as equity shares, is a small portion of a business that an individual buys in anticipation of future returns. When you purchase equity shares of a company, you become a shareholder of the organization. A shareholder is liable for the business’s profits and losses. The shareholder also gets the authority to vote on the major decisions of the company.
Apart from benefiting from any rise in the price of company stocks, equity holders may also get dividends from the company. Companies that are well-established and are larger in nature are more likely to provide dividends on their equity shares. They may also provide bonuses as they may have more assets and working capital in hand.
History of Equity Shares
One can trace the history of equity shares back to a small town in Belgium in the 1440s. The idea of trading was first introduced by a group of merchants gathered in the middle of town. These merchants started buying a large number of non-perishable goods, anticipating that the price of those goods are going to rise in the future.
The Dutch East Indian Company started shipping precious metals and goods across the world in 1611. Since the costs associated with shipping were expensive, the company asked citizens to invest money on the trading routes. In return for their investment, the citizens received a share of the profit made on the trip.
This in turn led to the formation of the world’s first stock exchange ‘The Amsterdam Stock Exchange’. The stocks of the Dutch East Indian company were then actively traded on this stock exchange. Looking at the success, many countries also started setting up their own exchanges to raise money from investors.
How do Equity Shares Work?
Equity shares function on the concept of demand and supply in the market. Basic economics states that the price of a good or service will go up with an increase in demand for the same, and vice versa. The same applies to equity shares, which means:
- If more number of people are selling the shares of a company, then the price of that stock will go down
- If more people are buying the stock of a company, then the price of that particular stock will go up
People buy or sell equities based on their understanding of the market. The investments are made by making assumptions regarding the future of a company:
- If the investors think that a company has a bright future, then they will purchase more of that stock. This will result in an increase in the price of that equity
- If the investors think that the company is not going to do well in the coming years, they will start selling shares of that company. This will result in the price of the share going down
Types of Equity Shares
The following are the different types of equity options that you can invest in:
These are the kind of shares that are issued by the company to the already existing shareholder without charging any additional prices. This is done by the companies in order to convert the company's total earnings into stocks. These bonuses are usually handed out to investors rather than paying out dividends.
These bonus shares are allotted to investors in a pro-rata manner. So, if investor X has 200 shares of HUL and the company declares that it has decided to allot 1:4 as bonus, then X will receive a further 50 free shares.
These are the types of equity shares that are made by a company to its current shareholders in order to buy new securities at a fixed price adhering to a stipulated time period. In short, right shares are new stocks of the company on which any existing shareholders have a right on before it is issued to the general public.
Much like bonus shares, these shares are also allotted to the shareholders in a pro-rata manner. Which means, if a company offers 2000 fresh shares, and an existing shareholder has rights to 2% of the previous lot, then they are eligible for 40 of the new shares.
Sweat Equity Shares
Sweat equity shares are usually issued by companies to its employees as recognition for a good job. This is usually a representation of a non-monetary contribution from an individual to the company. Thus, these are shares issued by a company to reward such actions. This method is used by several companies in order to increase employee retention.
Voting and Non-Voting Shares
Usually most equity shares that are issued by a company are considered as a stake in the company’s ownership, and have voting rights for the major decisions of the company. However, there are certain conditions in which companies issue shares which carry no voting rights with them.
For example, in the year 2008, Tata motors offered a fresh issuing of shares on the basis that 10 such shares would make for one vote in the decision making process. This is called differential voting rights.
Authorised Share Capital
Before issuing shares in the stock market, each public limited company has to specify the amount of share capital it wishes to raise. The amount specified in a company’s Memorandum of Association is the limit of money a company can collect by issuing shares. However, there are a number of legalities that can be used to raise the authorised share capital of a company.
Issued Share Capital
Issued share capital stands for the minimum value of the shares issued by a company. For example, if the base value of a share is ₹ 200 and a company issues 10,000 shares, then the issued share capital will be ₹ 20 lakhs.
Subscribed Share Capital
Subscribed share capital is the amount of issued share capital which has already been allotted to investors. With reference to the example given above, if the investors had purchased 5000 shares of the company, then the subscribed share capital will be ₹ 10 lakhs. In case all of the stocks issued by the company are bought, then the subscribed and issued share capital capital will be the same.
The amount that an investor pays for a share of the company is the paid-up capital. Generally, this amount is paid in full by shareholders, which means that the subscribed capital and paid-up capital are the same amount.
These refer to security options of a company that regularly pay out dividends. These are usually large companies with high income. Therefore, this investment tool is perfect for new investors or investors who are averse to risk taking.
These stocks are shareholding options for companies that are more likely to expand at an exponential rate. Holders of these stocks do not usually receive dividends, but are more likely to receive higher capital profits to the investor. These types of equity shares are perfect investment options for experienced investors with a higher risk aptitude.
These are the types of equity shares that are traded at a value lower than their actual price.They are perfect for veteran investors who can correctly predict the activity of the market.
Features of Equity Shares
The following are some of the characteristics of equity shares which makes them one of the most sought after investment tools today:
- Usually, the equity shares issued by companies carry a voting right to take part in the major decisions of the company. Shareholders have the right to choose individuals to look after the day to day business of the company. Appointing efficient leaders help in increasing the annual turnover of a company, thereby increasing the average dividend each shareholder receives
- The equity shares issued by an organization are non-redeemable and permanent in nature. These shares cannot be returned unless the company has decided to discontinue operations
- Holders of equity shares are liable to receive additional profits generated in a financial year. Any person having a considerable investment in the company will also experience an increase in personal wealth
- Equity shares are transferable in nature. Even though these shares are non-redeemable in nature, they can be transferred very easily. These shares can be transferred from one investor to the other
- There are many companies that pay out dividends with respect to the number of shares issued. The amount paid out in dividends depends on the profit made by a company and the fund availability of a company
- Even though they are one of the most sought after investment tools in the market, they are highly volatile. The risk factor associated with these shares is high, thus ensuring a greater return on investment. So an experienced investor with affinity for risk trading can build a very strong portfolio with these shares
Benefits of Investing in Equity Shares
The following are some of the benefits to investors who invest in equity shares:
Higher Return on Investment
As we’ve established earlier, equity shares are high risk investment options. As is the rule of the market, the higher the risk factor, the higher the returns potential. This is also a wise investment option as any shareholder also benefits from dividends and profit made by the company.
When an investor purchases equity shares of a company, they also claim a stake in the ownership of the company. Which means that the investor also gets a voting right in the decision making process of the company. The higher the number of equity shares, the more they have power in an organization.
Lack of Legal Obligations
Any equity shareholder of a company is not liable to be involved in the legal obligations of a company. The company operates as a separate legal entity from the investor. So in case the company is involved in any legal issues, the stakeholder is not responsible for it in any way.
By investing in equity shares, an investor can create a large and diverse investment portfolio. By diversifying your portfolio by investing in equity shares of different sectors, you can receive increased dividend payments. This creates a well balanced portfolio offering stable returns for a long time.
Easy and Efficient
Investing in equity shares is fairly simple than it sounds. An investor can easily invest in the share market with the help of a financial advisor or stockbroker. An individual can also open a Demat account and invest in the equities of companies of their choice.
Demerits of Investing in Equity Shares
Even though investing in equity shares has a number of benefits, you shouldn’t always expect a positive return from your investments. There is still a great chance that you might also incur a great loss while investing in the equity market. The shareholder may also face loss if the company fails to register a profit during a fiscal year. Some of the risks associated with investing in the equity market are as follows:
Dividend Payments are not Prioritised
Equity shareholders receive dividend payments when a company makes a profit. The equity shareholders have the last claim to these profits. The dividends are first distributed among bond holders and then among preference shareholders. The remaining amount is then distributed among the equity holders. Which means that if the amount of profit is low, then the majority of it will be given to bond holders. This leaves a very low amount to be distributed among equity shareholders.
As discussed before, the profit returns from equity investment is subject to the changes in the market. Bond holders on the other hand, face no market risks regardless of the price of the stock. This means that investing in the equity market does not guarantee assured returns. If the performance of the company is poor, it can lead to a drop in the share price of that company. This in turn will lead to shareholders selling their investments at a loss.
How to Buy Equity Shares
If you wish to invest in the equity market, you require the following three main accounts:
- Demat Account: This account is required to hold all the shares in the holder’s name
- Trading Account: This account is required to place, buy, and sell shares
- Linked Bank Account
The following is how you can invest in the equity market:
An IPO is a public listing announced when a company is launching its shares for the first time. An interested investor can buy these shares through their netbanking account. They can also place a bid for the company’s securities through stock exchanges.
If you are not able to purchase shares through an IPO, you can purchase them once they are listed on stock exchanges.
Why are Equity Shares Issued?
Companies usually issue equity shares in order to raise capital from its investors. The capital issued by the company can be used for a number of purpose like:
- Acquiring another company
- Developing future cash reserves
- Development and production of products
- Growth and expanding the business
- Settle outstanding debts
- Launching new products and services
Apart from bank loans, issuing equities is one of the ways a company can raise capital when needed. Most companies choose not to go for bank loans, as they are then liable to pay interest on the borrowed money. Companies therefore issue equity shares to avoid interest payment showing up as recurring liability on the balance sheet. One of the major advantages of issuing equities is that companies can then conserve cash more efficiently. In the case of stocks however, companies have no such obligation to pay back the borrowed capital.
It is fairly easy to create a large corpus using equity shares. The trick is to carefully select the right stock and invest in it. Finding the right stock to invest in requires a lot of deliberation and research. It is always advised that you should always be aware of the stock’s performance and potential before investing.
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Frequently Asked Questions (FAQ)
What is the purpose of equity shares?
These are shares that indicate a stake in the ownership of a company. Shares issued by a company act as a source of revenue for the company.
What are some examples of equity shares?
Some of the examples of equity shares are as follows:
Callable common shares
Putable common shares
Cumulative preference shares.
What are the benefits of buying equity shares?
Some of the benefits of investing in equity shares are as follows:
Greater return on investment
Voting rights for company decisions
No legal obligations