When discussing stock markets and companies, the term “Equity Shares” is probably the most frequently used. Shares, or Stocks are the portion of capital each shareholder is entitled to. These represent ownership in a specific company. When investors buy shares of a company’s stock, they become partial owners and may benefit from capital appreciation and dividends. Unlike mutual funds, investing in individual stocks requires direct decision-making by investors, who can choose stocks based on their research, risk tolerance, and investment goals. Individual stocks offer the potential for higher returns but also come with higher risk compared to diversified funds.
There are types of equity shares as well which are explained in brief below:
Common Stock
A company issues common stocks in exchange of capital raised to cover their expenses. They are also called common stocks. Purchasing these shares makes you a part owner of the business and the profits that may arise from the business.
Convertible Stocks
Convertible Stocks refers to a financial instrument that starts as a form of debt (like a convertible note) but can be converted into equity (ownership in the company) later, typically during a future financing round. This provides investors with the potential for both interest payments and the opportunity to convert their investment into company shares, allowing them to participate in the company’s growth.
Bonus Shares
Bonus shares are like a special reward a company gives to its shareholders using the profits it has saved up. Instead of giving out cash, the company distributes extra shares to its existing shareholders. However, this doesn’t make the company’s overall value on the stock market go up.
Rights Shares
Rights shares aren’t available to everyone. A company offers these shares to specific premium investors. This special kind of share allows those investors to increase their ownership in the company. The shares are sold at a lower price, and the goal is to raise money for the company’s financial needs.
Preferred/Preference Shares
Unlike ordinary equity shares, owners of these preferred shares are not entitled to vote or ownership. On the other hand, before distributing profits to common shareholders, investors purchasing preference shares are guaranteed a cumulative dividend payment. Preference shares are divided into two subcategories:
Participating Preference Shares: This entitles you to a portion of the earnings, which may include bonus shares.
Non-participating preference shares: In this category, no bonus shares or profits are shared with you.
Sweat Equity
When directors and employees do outstanding work for a company, they might receive sweat equity shares. These shares are given at a discount as a way of recognizing their contributions in terms of ideas, expertise, or other valuable additions to the company.
Employee Stock Options (ESOPs)
Companies use ESOPs to motivate and retain their employees. Employees get the chance to buy company shares at a set price in the future according to the terms of the ESOP. When employees and directors decide to use their ESOP option, they receive shares in return.
What are Equity Mutual Funds?
Equity mutual funds pool money from multiple investors to invest in a diversified portfolio of stocks. Investors buy units or shares in the mutual fund, and their returns are proportionate to the fund’s performance in the stock market. These funds are managed by professional fund managers who decide buying and selling stocks based on the fund’s objectives.
Advantages of Equity Shares
Potential for High Returns
Equity shares carry the possibility of yielding significant returns due to their high-risk nature. The principle of higher risk often translates to higher rewards. These shares exhibit high volatility, with prices fluctuating based on various factors such as demand, supply, economic conditions, company performance, geopolitical influences, and more.
Extra Earnings from Bonus
When the business generates larger profits, some are given to equity shareholders as bonus shares. It raises the quantity of equity shares you own without requiring you to make further payments. Your investment’s value increases in tandem with the share market price.
Voting Rights
Equity owners have the authority to determine how the business is run, including who gets chosen to lead it. An organization with effective management increases profits and pays out larger dividends to its owners.
Liquidity
Listed Shares are easily traded on the stock exchange, making buying and selling quite easy.
Limited Legal Obligations
Despite being partial owners of the company, equity shareholders face restricted legal responsibilities.
Disadvantages of Equity Shares
Company’s Performance
The performance of the shares depends a lot on how well the company is doing. If the company isn’t making profits, equity shareholders might not get any dividends.
Capital Loss
Because equity shares are risky, there is a chance of losing money. The share price can go up and down due to various reasons, leading to potential losses for investors.
Volatility
Share prices can be unstable for many reasons, influenced by market sentiments. Trying to predict the market’s timing is nearly impossible. Share prices can change within seconds, making it a challenging strategy.
Frequently Asked Questions
1. What is meant by equity in a stock?
In stocks, equity refers to an ownership interest in a company. It represents the residual interest after deducting liabilities from assets. Equity holders, such as common stockholders, have a claim on the company’s assets and earnings.
2. How do equity shares differ from other types of shares?
Equity shares represent ownership in a company and confer voting rights. They offer the potential for capital appreciation and dividends. Unlike other shares, equity shares do not have fixed dividends; holders bear the highest risk but have the greatest potential for returns.
3. Are there different classes of equity shares?
Yes, companies can issue different classes of equity shares, each with unique rights and privileges. Typical classes include common stock and preferred stock. Preferred stockholders often have priority in dividend payments and liquidation, while common stockholders have voting rights.
4. What are the risks associated with investing in equity shares?
Investing in equity shares carries market volatility, company-specific risks, and economic factors affecting stock prices. Market fluctuations can lead to capital loss, and individual companies may face operational challenges impacting stock values. Additionally, investors may be exposed to geopolitical and macroeconomic uncertainties.
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