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What are Equity Shares?
By Bajaj Broking Team
February 16, 2024
9 mins read
Authorized Person
Equity shares are the type of shares issued by a company. They represent ownership in a company and are also known as common stock or ordinary shares. Equity shares are an important source of finance for companies, enabling them to raise capital and expand their businesses. Equity shareholders have voting rights and can influence the decisions made by the company. Equity shares also entitle the holder to a share of profits when the company declares dividends. In short, equity shares meaning, or equity shares definition is that they are the part ownership of a company and bring with it the right to receive a share of the profits. Now that you know “what is equity share”, let’s discuss the topic further.
Types of Equity Shares
The four main types of equity shares are:
1. Preference Shares
Preference shares are equity shares that provide shareholders with a fixed rate of return. These shares are also known as 'preferred stock'. Preference shareholders do not have voting or management rights but are paid dividends before the common shareholders.
2. Common shares
Common shares are the most widely held equity shares. Common shareholders have voting rights and are entitled to a share of the profits when the company declares dividends.
3. Bonus Shares
Bonus shares are additional shares given to existing shareholders without any additional cost. Instead, the company issues these shares out of its profits or reserves. As a result, bonus shares increase the number of equity shares outstanding, which can positively affect the share price.
4. Right Shares
Right shares are those offered to existing shareholders at a discounted price. The company issues these shares to raise additional capital. Right shares are issued in proportion to the number of existing shares held by the shareholder.
Features of Equity Shares
Here are some characteristics of equity shares:
1. Voting Rights
Equity shareholders are empowered with the right to determine how the business is steered, including selecting the right individuals to be in charge. This is an important factor leading to the success of any company, as effective management produces higher profits and better dividends for its shareholders. Thus, voting rights are essential for the shareholders to ensure that the company is well-run and has a bright future.
2. Additional Profitss
Bonus shares are a great way to increase the financial returns of equity shareholders. They are an additional source of profit as they are issued when the company makes higher profits. By increasing the number of equity shares held by an investor without any additional investment, bonus shares can increase the value of the investment when the market price of the shares goes up. This provides shareholders with an additional profit, making bonus shares a great way to benefit from the company's success.
2. Additional Profitss
Bonus shares are a great way to increase the financial returns of equity shareholders. They are an additional source of profit as they are issued when the company makes higher profits. By increasing the number of equity shares held by an investor without any additional investment, bonus shares can increase the value of the investment when the market price of the shares goes up. This provides shareholders with an additional profit, making bonus shares a great way to benefit from the company's success.
3. Liquidity
Liquidity is an important factor to consider while investing in equities. It refers to the ease with which an investor can sell his equity holdings and convert them into cash. Equity shares have no maturity period, so one can easily sell them in the secondary market. This gives investors great flexibility as they can liquidate their holdings whenever required. Furthermore, holding equity shares for an extended period also reaps the rewards of capital appreciation.
For instance, if you have held shares of a company for a long time, and the company has performed well over the years, you could have participated in bonus and rights issues. This could have enabled you to create greater wealth due to the rise in the share price over the years. Liquidity is one of the best features of equity.
4. Ownership Rights
Equity shareholders are the company's owners and are thus entitled to a share of the profits. They are also entitled to a share in the company's assets in case of liquidation. In addition, equity shareholders have the right to attend the annual general meetings and influence the decisions made by the company. These are some of the features of equity shares.
Advantages and Disadvantages of Investing in Equity Shares
Advantages
- Capital Gain: Equity investments carry the potential for capital appreciation over the long term. This means that if the market price of the shares goes up, the investor benefits from the increase in the value of his or her holdings. This is one of the major advantages of investing in equity shares.
- Limited Liability: Limited liability protects equity stockholders from personal responsibility for the company's obligations. This means that the company's equity stockholders are completely immune to any losses sustained by the business.
- Exercise Control: The real owners of a corporation are its equity shareholders, who have the final vote in how the corporation is run. They have a significant say in running the business and can vote on major issues. Shareholders have voting rights and can collect dividends from the corporation. In addition, shareholders have the right to vote on important issues, including the election of directors, the approval of critical financial decisions, and the amendment of the company's articles of association.
- Claim over Assets & Income: Equity shareholders are the company's owners and have a claim over the assets and income of the company. Therefore, in liquidation, equity shareholders will be the first to receive the proceeds after all liabilities have been paid off.
- Stock Split: Stock splits are a sort of corporate action in which the company's equity shares are diluted by issuing a new class of shares to the public. As a result, the share price may rise as the lower per-share market price will attract more buyers.
Disadvantages
- High Risk: Equity investments might carry a high degree of risk. The value of equity shares can vary significantly due to several factors, such as government policies, macroeconomic conditions, market sentiment, etc. As a result, investors must be prepared to bear losses in the event of a downturn in the market.
- Fluctuation in Market Price: The stock market is very volatile, and the price of equity shares can fluctuate significantly. This is mainly due to the influence of market forces that are beyond the investor's control. Thus, it is possible that in a matter of days, the value of shares can significantly increase or decrease. This makes investing in the stock market a risky yet potentially rewarding endeavour.
- Limited Control: The influence of the company's equity investors on management is limited. Investors have a voice in the company's governance and can vote on critical issues, although most shareholders ultimately have the last say.
- Residual Claim:Equity shareholders are the last to receive their share of the profits since debt holders are paid before them. This is because they are considered residual claimants in the company. Equity shareholders are the ones who will receive whatever is left after all the other expenses, debts, and liabilities have been paid off. This benefits the business since it means that equity shareholders are taking a risk with the company and will be rewarded if it succeeds.
What are the Risks Associated with this Investment?
Equity investments come with their own set of risks. Here’s a quick look at some of the most common risks.
- Economy Risk: The economic performance of the country influences the performance of the equity market. The markets are likely to perform well if the economy is healthy. Economy risk is the risk of underperformance of equity investments due to less-than-ideal economic scenarios.
- Financial Risk: Financial performance is another major factor influencing the equity market. Strong revenue-generating capacity, low debt obligations and consistent profits are key to the good performance of equity investments. Financial risk is the risk of equity investments underperforming due to bad financial performance.
- Industry Risk: An industry cannot keep growing all the time. In fact, most industries go through cycles of growth and decline. Industry risk is the risk of underperformance of equity investments due to industry declines.
- Exchange Rate Risk: Many companies generate major portions of their revenue from outside India. In such scenarios, the foreign exchange rates play a huge role in determining profitability. Exchange rate risk is the risk of a decline in the value of equity investments due to foreign currency fluctuations.
How to Buy Equity Shares?
Thanks to the advent of electronic trading, purchasing equity shares of companies has now become easier than ever. Here’s a short guide on how to get started.
- Since shares are now mandatorily required to be held electronically, you need to first open a demat account with a Depository Participant. A demat account is used to digitally store the shares that you purchase online.
- Once you’ve opened a demat account, the next step is to open a trading account with a stockbroker. A trading account lets you purchase and sell equity shares and other securities online.
- With the trading and demat accounts up and running, the next step is to log into your stockbroker’s trading portal.
- Upon logging in, all you need to do is enter the name of the stock in the search bar and enter a few details such as the number of shares and the price at which you wish to buy.
- Once you’ve entered all the relevant details, proceed to place the order. The requisite funds will be debited from your trading account so make sure to first keep your account well funded.
- The buy order will be placed and sent to the relevant stock exchange where it will be matched with a similar sell order.
Difference between Equity Shares and Preference Shares
| Equity Shares | Preference Shares |
|---|---|
| shareholders have voting rights | shareholders do not have voting rights |
| shareholders have a greater say in the running of the business | hareholders are usually entitled to a fixed rate of return |
| shareholders are entitled to a share of the profits when dividends are declared | hareholders are paid before dividends are declared |
| shareholders also claim over the company's assets in the event of liquidation | hareholders have a lower claim |
What are the Alternative Investment Options?
Alternative investments are options outside the scope of traditional investments, such as stocks, bond, and cash. These investments include real estate, commodities, private equity, hedge funds, and venture capital. They offer a variety of benefits, such as diversification, the potential for higher returns, and the ability to invest in non-traditional asset classes.
Conclusion
Equity shares are an important source of finance for companies. They represent ownership in a company and entitle the holder to voting rights, a share of profits, and ownership rights. Equity shareholders can benefit from capital appreciation and bonus issues and have the flexibility to liquidate their holdings whenever required. However, equity investments might carry a high degree of risk, and the value of the shares can fluctuate significantly.
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