The Basics of Equity Shares

Equity Shares

The stock market offers numerous products for investment and trading purposes. A few of them are mutual funds, equity, IPO, NCDs, bonds, derivatives, etc.

Today, let us explore in detail about the entire Equity Market commonly known as Equity Shares.

In this article, we have explained

  • History of Equity Shares
  • What are Equity Shares?
  • Why Do Companies Issue Equity Shares?
  • Advantages of Equity Shares
  • Limitations of Equity Shares
  • Why do investors buy Equity Shares?
  • How do Equity Shares Work?
  • What are the Other Types of Shares Available?

History of Equity shares

In the small town of Belgium in the 1400s, few merchants assembled in the middle of a town from all around the world. They started buying non-perishable goods in anticipation that the prices might rise in the near future. This initially introduced the practice of trading.

Later in 1611, the Dutch East Indian company shipped voyages of precious goods such as Gold, Porcelain, Spices and Silks across the globe. As the shipping costs were expensive, the companies approached citizens to invest money on the trip. In return, they offered a share of the profits that the trip would make.

This practice initiated the first stock exchange in the world called ‘The Amsterdam Stock Exchange’. For many years, the shares of the Dutch East India company were actively traded on this exchange.

At this point, other countries began creating similar stock exchanges and investors used to buy and sell shares of companies.

In the 1800s, this practice started in India where 5 Stockbrokers met under a banyan tree. Here, they exchanged shares of companies. Two decades later, as the number of brokers increased, a small group was formed ‘The Native Share & Stock Brokers Association’. Now it is known as the Bombay Stock Exchange (BSE). BSE is the oldest stock exchange in India and Asia where more than 3000 Equity shares of companies are listed and traded.

What are Equity Shares

What are Equity Shares?

Equity shares are the most widely-traded form of stocks in India. A Stock is a small part of the company that an investor buys in anticipation of future profits. When you own a stock, you become a shareholder of a company. Also, you are eligible for the company’s profits and losses.

Each shareholder gets voting right through which he can vote and help the company in major decision making.

Besides profiting from any rise in value, the equity shareholders might also receive dividend payments from the company whose stock they own. Typically, larger, better-established companies are most likely to pay dividends and bonuses as they have more assets in hand.

So, even if you buy 1 share of a company, you become entitled to the profits and losses earned by the company and get voting rights.

Why Do Companies Issue Equity Shares? 

The primary goal for issuing equity shares is raising capital from investors. The capital that is raised by the company can be used for multiple purposes such as,

  • Acquisition of a company
  • Creating a future cash reserve
  • Expansion
  • Paying off outstanding debts
  • Launching new products

The major advantage of issuing equity shares instead of bonds is that the company can conserve cash effectively. Bonds require periodic interest payments and the repayment of the principal amount that is borrowed. This drains cash from the business.

However, in the case of stocks, a dividend is an optional payment to the shareholders. Many companies don’t pay dividends. This helps them conserve more cash.

But in the case of bonds, defaulting in interest payment can lead to rating downgrades.

Advantages of equity shares

1. Voting rights

Voting rights are given to investors who buy a share of the company. These voting rights allow investors to vote on corporate policies and major business decisions. The more equity shares an investor has the more power they have to take decisions in a company.

2. High Returns

Over the years, equity shares are one of the few investment options which have provided inflation-beating returns.

3. Limited legal liabilities

Beyond financial investments, profits and voting rights, the holders of equity shares have limited legal liabilities. So, if the company gets into legal issues, the shareholders are not responsible in any case.

4. Liquidity

Equity shares can be easily bought and sold by investors as they are highly liquid. Liquidity helps investors not only to buy shares quickly but also sell them if the company is not performing up to the mark.

Limitations of Equity shares

1. No priority over dividend pay-outs

When the company is in profits and is allocating dividend pay-outs to investors, equity shareholders are the last ones to get the advantage of it if any.  They receive their dividends after preferred shareholders and bondholders have received their dividends and interests. Hence, there is a degree of uncertainty and a lack of control over dividend pay-outs.

2. Market Risks

Returns from the stock market are not guaranteed. If the company declines in performance, it can lead to falling share prices and investors might liquidate their positions. Hence, equity shares are risky in nature.

Why do Investors Buy Equity Shares? 

Investors are constantly looking for ways to grow their hard-earned money. Moreover, equity shares have historically provided the best returns amongst all other asset classes.

Hence, investors buy stocks to,

  • Participate in the growth of the company
  • Earn regular income from dividends
  • Earn bonus shares to increase their shareholdings
  • To acquire voting rights and be a part of key decision making.

How do Equity Shares Work?

Equity shares work on the concept of demand and supply in the market.

  • If more people are selling the stock of a company, the stock price will fall &
  • If more people are buying the stock of a company, the stock prices will rise.

People buy or sell stocks based on their assumptions about the future of the company.

  • If they believe that a company will perform well in the upcoming years, they will buy the stock.
  • If they believe that a company will perform poorly in the upcoming years, they will sell the stock.

Demand (buying) and supply (selling) help in determining the price of a share in the market.

How to Make Money by Investing in Equity Shares? 

There are two approaches to make money by investing in equity shares.

1. Active investing

The active investment strategy is a short-term strategy in which investors hold stocks for a smaller duration.

This ranges from,

  • Trading for a few seconds (scalping)
  • Trading for a few minutes to hours (intraday trading)
  • Trading for days (swing trading)

The primary aim of active investing is to generate quick profits. Active investing is most suitable for individuals with a high-risk profile and who can actively

track market movements.

2. Passive investing

Passive investment is a long-term strategy that works on the ‘buy and hold’ principle. In passive investing, investors buy stocks with an aim to hold them for a very long term.

Coffee-can investing is a classic example of passive investing. This investment is suitable for investors with a moderate to low risk appetite and a long time horizon.

What are the other Types of Stocks?

Companies normally issue two types of stocks:

  • Equity shares
  • Preference shares

While both equity and preferred stocks represent the ownership of a company. Let us look at the difference between equity shares and preference shares

Parameters Equity shares Preference shares
Voting rights Common shareholders get voting rights Preference shareholders do not get any voting rights
Claim on dividends Common shareholders are the last to get dividend payments. Preference shareholders are the first to receive dividends.
Preference while winding up Common shareholders are the last to get paid in case of bankruptcy. Preference shareholders get paid before common shareholders in the event of bankruptcy.
Cost of issue The cost of issue is high The cost of issue is low

Final Thoughts

The legendary investor Warren Buffet has forever believed in passive investment strategy.

He believes in buying quality stocks for the long term which resulted in his wealth creation journey from US$ 38 to a whopping US$ 88.6 Billion!

However, good quality stocks are the hardest to discover. It takes decades of knowledge, expertise, and a keen eye on the fundamentals of the stocks.

[Suggested Reading: Best Large Cap Stocks to buy now in India]

To invest in the best long-term stocks in India, open a Demat account with Samco and get access to a unique 3-in-1 investment account.

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