Equities are ownership in an enterprise and allow investors to accumulate wealth in the long run. In contrast to fixed-income investments, equities in the stock market have greater potential for returns but involve risks such as market volatility. Therefore, familiarity with how equities function, their advantages and related risks is essential in making sound investment choices. This in-depth guide will cover everything from what are equities to investment strategies so you can confidently face the stock market and create a solid financial future.
Meaning of Equity
Equity shares represent ownership in a firm and give shareholders an equivalent share in its profits. When investors purchase equity shares, they become part owners and can gain through capital gains or dividends. Equity is shown in a company’s balance sheet and depicts its financial position.
In addition, equity shareholders have voting rights in firm decisions, such as electing board members. Though equity investments may provide lucrative returns, there are risks due to market changes. Hence, investors must calculate their risk quotient and do background research before investing to keep losses to a minimum.
Features of Equity
Understanding the features of equities in the stock market is crucial for a trader. Here are the main features of these shares:
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Ownership Stake
Equity shares signify a company’s ownership and provide shareholders with an interest in its assets and earnings. Therefore, when buyers buy equity, they become partial owners, entitled to rights and obligations based on the company’s performance.
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Return on Investment (ROI)
Shareholders enjoy capital appreciation or dividends if the business performs well, as one of its main characteristics is the Return on Investment (ROI). However, equity holders experience risk and reward because stock prices are volatile, indicating they can incur losses if the business underperforms.
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Residual Claim
Equity shareholders hold a residual claim, as they will be last in line to receive payments if a business faces any loss, after paying off debt and liabilities. With this risk, holding equities in the share market includes voting rights, where investors can vote on key company decisions, such as appointing the board of directors.
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Liquidity
Equity shares can be sold on stock exchanges, although their price fluctuates depending on market trends. This is because there is no fixed repayment schedule for equity.
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Limited Liability
Equity shareholders have the privilege of a company’s ownership, but their liability is limited. This means their liability is limited to the share value they have invested in.
Working Mechanism of Equities
Knowing what is equity enables investors to become part owners of a firm with the potential for gains through capital appreciation and share price appreciation. When investors purchase shares, they can resell them later at a higher price to realise returns. Hence, shareholders can receive dividends if they hold the equities for the long term and the company pays out profits.
Investing in a company grants shareholders voting rights and control over business decisions. Equity investments have associated risks since share prices depend upon market situations. Therefore, investors should assess their risk appetite before investing in equity shares to maximise returns and minimise losses.
Different Types of Equities in the Stock Market
Equity shares provide investors with several opportunities for wealth generation, but choosing the right one needs careful consideration of risk appetite and investment objectives. They may be classified into the following types:
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Ordinary Shares
Ordinary shares are the most prevalent type of equity shares, which give rights of ownership and voting rights to investors. The shareholders may influence the management decisions, especially if they own a large percentage of the shares. In addition, the shares yield returns in the form of capital appreciation and dividends but have greater risks involved.
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Bonus Shares
Bonus shares are issued from a company’s retained earnings, offering additional shares to existing shareholders at no cost. Instead of paying dividends, companies may distribute these equities in the share market on a pro-rata basis. For example, if a company declares a 1:4 bonus, an investor holding 200 shares will receive 50 extra shares for free.
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Rights Shares
Rights shares enable current shareholders to purchase extra shares at a lower price before the company issues them to the public. They are distributed on a pro-rata basis. For instance, if an investor owns 2% of a company’s current shares, they can receive 2% of any new shares that are issued.
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Sweat Equity Shares
Firms pay employees or directors sweat equity shares as a reward for their non-cash contribution, like innovation or expertise. It aids in retaining workers by providing them with a share in the firm’s ownership.
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Differential Voting Rights (DVR) Shares
Some firms offer shares with differential or limited voting rights. For instance, Tata Motors offered ‘A’ shares in 2008, which were such that 10 shares would have one vote but a 5% higher share in profit than normal shares.
Reasons for Investing in Equities
Investing in equity shares can increase your wealth in the long run, making them a favoured investment choice. Here are the reasons for investing in equities:
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Profit Potential
Equities can help you earn high returns, generally surpassing other investments. Investing in strong businesses for the long term can yield significant capital gains. For example, a ₹20 small-cap stock today may grow manifold if the business grows well.
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Beating Inflation
One of the greatest advantages of equity share investments is that they can generate returns that exceed inflation. Moreover, inflation destroys the purchasing power of money, but successful stocks can assist investors in keeping and even improving their financial position over time.
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Dividend Income
Several companies pay out part of their earnings as dividends, providing investors with a regular source of income. Long-term investors usually like firms with steady dividend payments as they offer security while still providing the possibility of capital appreciation.
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Ownership and Voting Rights
Investing in a company’s equity shares grants you partial ownership and voting rights. Additionally, shareholders can participate in important company meetings and influence key decisions, making them more than passive investors.
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Rights Over Assets and Profits
Equity shareholders own a portion of the company’s assets and profits. As the company grows and becomes more profitable, shareholders benefit through dividend payments and stock price appreciation.
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Portfolio Diversification
Equity investments diversify an investor’s portfolio, minimising risks arising from market volatility. Investing in various industries means that poor performance in one sector can be balanced by profits in another, making the overall stability better.
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Hedge Against Inflation
Equity investments increase in value over time, providing returns higher than inflation rates. This ensures that investors can keep their purchasing power and strengthen their financial standing in the long term.
Risks Associated with Investing in Equities
Investing in equity shares is lucrative, but it also involves inherent risks that investors need to consider before making a choice. Here are a few risks associated with equity investment:
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Market Volatility
Stock prices are volatile because of economic conditions, the company’s performance, and investor sentiments. Even fundamentally sound stocks can fall sharply during economic slumps, so equity investments are extremely volatile.
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No Guaranteed Returns
Equity shares do not come with a guarantee of returns, unlike fixed-income securities. Moreover, investors may experience losses due to a company’s share price falling from operational issues, sector upheavals, or economic slowdowns.
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Uncertain Dividend Payouts
Equity shareholders get dividends only if a firm chooses to distribute profits. In addition, dividends are only given after payments are made to bondholders and preferred shareholders. Investors cannot receive dividends if a firm invests its profits in growth.
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Capital Loss Potential
Equity investments have the risk of capital loss if the company underperforms. Stock prices fall drastically because of poor financial management, market downturns, or poor industry trends, resulting in huge financial losses.
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Requirement of Market Knowledge
Investing in equities involves careful market study and company analysis. Investors who do not have sufficient knowledge may invest in poor investments, like stocks of financially unhealthy companies, causing losses.
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Impact of Management Decisions
Shareholders have a limited say in a firm’s strategic direction. Inept management decisions, like poor acquisitions or inefficient resource use, can negatively affect stock prices and shareholder worth.
Steps to Invest in Equities
Equity investments involve creating the required accounts and authenticating your details. Here is a step-by-step procedure for getting started:
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Step 1: Register on a Trading App
Register on a trading platform, like Torus Digital, with your mobile number and email ID. Create an mPIN for extra security.
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Step 2: Open a Savings Account
You need a savings account for equity investments. Open one by using your Aadhaar card.
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Step 3: Open Your Investment Account
To invest in equities, open a trading and Demat account using your Aadhaar and PAN number. The trading account permits the buying and selling of shares, and the Demat account holds your holdings online.
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Step 4: Confirm Contact Details
Make sure your mobile number and email ID are confirmed so that you get important trading-related alerts.
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Step 5: Confirm Address and Bank Details
Submit a valid address proof and link your bank account for seamless transactions.
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Step 6: Finish KYC by Uploading Selfie and Signature
Upload a scanned copy of your signature and a selfie as part of the Know Your Customer (KYC) procedure.
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Step 7: Digitally Sign and Begin Trading
After confirming all details, digitally sign your account and start investing in equities.
Final Words
Henceforth, investing in stocks can be a profitable experience with the potential to create wealth, ensure financial independence, and diversify your portfolio. However, risks need to be understood, complete research has to be done, and investments made according to financial objectives. So, keep yourself informed about what areequities and market trends to handle risks prudently, and take a long-term view to optimise your returns on equity investment.
Open a FREE Demat Account with Torus Digital today and get started with equity trading!
