What are Equities?

Equities - Meaning & Definition

When people talk about investing in the stock market, the first question comes in mind is what is equity ? equities refer to the shares that represent ownership in a company. When you buy a company's shares you become a partial owner of that company. 

As a shareholder you can make money in two main ways through increases in the stock price known as capital gains)or dividends that the company may pay out. Owning shares also often gives you the right to vote on important matter, like choosing members of the Board of Directors (BOD).

Equity investments are becoming increasingly popular because they can offer high returns. However, they also come with risks. Investors need to understand their risk tolerance and do thorough research to minimize potential losses. 

Equities vs. Stocks

Now you understand equity meaning, let’s explore the difference between equities vs. stocks. The table below will help in defining equity and show how it different to stocks.

Types of Equity

1. Common Stock: Represents the money shareholders invest in the company. Holders of common stock have the right to vote on company matters and have a claim on the company's remaining assets.

2. Preferred Stock: Similar to common stock but does not come with voting rights. Preferred stockholders receive fixed dividends which are guaranteed.

3. Contributed Surplus: This is the extra amount investors pay above the par value when buying stocks. It also includes profits and losses from selling shares.

4. Retained Earnings: This is the portion of a company’s net income that is kept rather than paid out as dividends. Retained earnings are reinvested in the company or used to pay off future obligations.

5. Other Comprehensive Income: This includes income that hasn’t yet been realized and is not included in the net income on the income statement.

6. Treasury Stock: This is a contra equity account that shows the amount of common stock the company has bought back from shareholders. It is recorded as a deduction from total equity in the company’s financial statements.
 

Features of Equity

1. Maturity Period: Equity shares provide long term funding for a company and stay invested as long as the company operates. Investors can only get their money back if the company is liquidated and this happens after all other debts are paid.

2. Shareholders’ Voting Rights: When you buy equity shares you become a stakeholder in the company. This means you can attend company meetings and share your opinions on important decisions, influencing the company’s direction.

3. Income from Equity Shares: Investing in equity shares allows you to share in the company's profits. If the company does well you may receive higher dividends or benefit from an increase in the stock price. However, if the company doesn’t make enough money you might not earn anything.

4. Claim on Company’s Assets: Equity shareholders have a claim on the company’s assets. If the company is liquidated they are entitled to a portion of what’s left after all other debts have been paid.

5. Limited Liability: Although shareholders are considered owners of the company, their financial responsibility is limited to the amount they invested in shares. This means their personal assets are protected from the company’s debts and liabilities.

How to Invest in Equities?

There are several popular ways to invest in equities:

1. Individual Stocks: You can buy shares of specific companies. Research companies based on their performance, industry trends and growth potential then buy or sell these stocks through a brokerage account.

2. Exchange Traded Funds: ETFs are investment funds that trade on stock exchanges and include a mix of stocks that follow a specific index, sector or theme. Investing in ETFs allows you to get a diversified portfolio of stocks in one go offering flexibility and ease of buying and selling.

3. Mutual Funds: These funds gather money from many investors to create a diversified portfolio of stocks managed by professional fund managers. You can choose mutual funds based on your investment goals and risk level. They are convenient for those who want a more hands off approach to investing.

4. Robo Advisors: These are online platforms that use algorithms to create and manage investment portfolios for you. They consider your risk tolerance and goals while offering various investment options including equities. Robo advisors are a low cost and simple way to invest.

Equity Shares Formula

To find a company's equity, you can use this simple formula:

Shareholders’ Equity = Total Assets - Total Liabilities

You can find the information needed for this calculation on the company's balance sheet by following these steps:

1. Find Total Assets: Look for the total assets listed on the balance sheet for the company.
2. Find Total Liabilities: Look for total liabilities which will also be listed on the balance sheet.
3. Calculate Shareholder’s Equity: Subtract the total liabilities from the total assets. This result gives you the shareholders’ equity.
4. Understand the Relationship: Remember that total assets equal the sum of total liabilities and total equity.
 

Equity Mutual Fund Investments

Mutual funds are nothing but types of investment where the capital from a myriad of investors is collected, collaborated and further invested in various equity and debt instruments. These funds are those wherein about 60% of the overall assets are primarily invested in different company shares. These shares are further distinguished depending on their market capitalisation as follows. 

1. Large cap equities 

These funds comprise investments only in certain prominent companies and have the ability to offer stable returns at a supposedly lower risk. 

2. Mid cap equities 

Midcap funds are primarily invested in the shares of several midcap companies. They are considered the most reliable investment options due to their balanced risk reward ratio. 

3. Smallcap equities 

These funds are invested in the stocks of corporations with a small market capitalisation. They are much more volatile than most types of investments. 

4. Multicap equities 

These funds are readily available to invest in several sectors and market capitalisations. 

Benefits of Equity Shares

High returns 

Equity shares offer comparatively higher returns to investors. Shareholders can thus get an edge over their investments to further enjoy wealth creation not only by dividend earning but also by capital appreciation. 

Convenience of Investment 

Investing in shares is rather effortless. Investors can get access to the services of a financial planner or stockbroker to invest in significant stock exchanges that are taking place. 

Offers security against Inflation 

Individuals investing in equity shares have the capacity to earn high returns. The return rates earned are much more than the rates of wearing down of an individual’s buying potential because of inflation. Due to this, equity shares offer a barrier against inflation.
 

How Shareholder Equity Works?

Investing in equity shares is popular because they can provide high returns.

Here's how shareholder equity works:

• When you invest in a company's stocks you can make money through capital gains or by the stock price going up.
• Additionally, owning shares gives you the right to vote on important decisions related to the company's Board of Directors.

However, while equity shares can be profitable they also come with risks. It's important for investors to understand their risk tolerance before investing in stocks.

What are the Advantages of Investing Equities?

High Returns: Investing in equity shares can bring high returns not only through dividends but also by the increase in stock prices over time.

Protection Against Inflation: Equity investments often provide returns that are higher than inflation helping protect your purchasing power.

Easy to Invest: It's simple to invest in shares through stock exchanges like NSE or BSE. With a Demat account you can buy shares in just a few minutes.

Diversification: While many investors stick to safer options like debt instruments these don't always provide high returns. Adding equities to your portfolio can increase your chances of higher gains.

What are the Disadvantages of Investing Equities?

While investing in equity can be rewarding it also comes with some risks:

High Market Risk: Equity investments can offer good returns but come with high risk compared to safer options like debt instruments. Investors could lose their entire investment.

Performance Risk: Stock prices depend on market conditions and may not perform as expected. This risk affects individual stocks as well as whole sectors.

Inflation Risk: Rising inflation can reduce a company’s value which might lead to lower returns on its shares.

Liquidity Risk: If a company struggles financially investors might have to sell shares at a much lower price than their actual value.

Social and Political Risk: Changes in government policies or social issues can impact businesses. For example, local businesses may benefit if the government restricts foreign competition
 

Equities and Dividends

Now you have an idea about what is equity in stock market. Equities represent ownership in a company and shareholders can benefit through two main avenues capital gains and dividends. When you own equity shares you become a partial owner of the company allowing you to earn profits if the stock price increases. Additionally, companies may distribute a portion of their profits to shareholders in the form of dividends. Dividends are usually paid regularly (e.g., quarterly) and provide shareholders with a direct return on their investment.

Not all companies pay dividends some prefer to reinvest their profits to drive further growth. Dividend paying companies are often more stable providing a source of income to investors. However dividends are not guaranteed and can vary depending on the company’s performance. Equities offer growth potential but they also carry risks including fluctuations in dividends and stock prices.

Conclusion

Although equities are a popular investment option it’s important to ensure they align with your financial goals and risk tolerance. Make sure you understand how equities work and the potential risks involved. Before diving into equity investments consider opening a free Demat account with 5paisa and make well informed choices.