Understanding Equity Investment Benefits, Risks and How it works

Understanding the equity market can feel overwhelming and complex for beginners and novices. Every company needs funds to run its business. When companies need to expand their business or run short of funds, they may choose to raise capital from their net earnings, avail an interest-heavy business loan or raise funds from the public. To raise equity capital, public-limited companies sell their ownership stakes in the form of shares to potential investors. This method of raising capital is known as equity funding. Also, buying and holding a share in a company is called an equity investment.

A financial definition of equity, as an asset class, is a stock, share or similar security that is offered by a company which an investor can claim ownership of. An investor who owns equity becomes a part-owner or stakeholder of that company. For example: if you buy 200 shares of a company that has a total of 10,000 shares on the equity market, then you are the owner of 2% equity of that company. Also, equity represents the amount of funds that will be paid out to the stakeholders if the assets of the company were liquidated, and all its debts paid off.

Owning equity in a company lets you be a part of the profits and losses of that company. You may also get voting rights (only some classes of shares offer voting rights to the investors) and be eligible to potentially earn additional money in the form of dividends, if any. Investors purchase equity in a company with the hope that the securities will rise in value so that they can get potential capital gains. When an equity investment rises in its value, investors can choose to sell their holdings and gain potential profits from that trade. Equity investments are a great addition to an investment portfolio as they can help achieve your long-term financial goals. However, as the price of the equities varies with equity market movements, underlying company performance, government policies, among others, it is best to exercise caution while investing in equities or any market-related securities.

Benefits and Limitations of Equity Investment

Below are some of the key benefits of equity investment:

• Capital Gains and Dividends: There are two types of income that you can potentially earn when you invest in equities. When the share price of an invested company goes up, you will receive a return on investment (ROI), i.e., capital gains. Also, when a company makes a profit, you might be eligible to earn from those profits in the form of dividends. Some companies may not provide dividends to their stakeholders.
• Bonus Shares: Bonus shares are shares that are sometimes issued by a company to the existing shareholders at no extra cost. This helps encourage retail participation and helps enhance the equity base of the company. However, not all companies offer bonus shares to their shareholders.
• Liquidity: Unlike many investments, such as real estate, the equities that are bought on an equity market have higher liquidity. Hence, you can easily buy/sell the shares or transfer your holdings to a different owner/brokerage account.
• Stock Splits: Some companies may decide to split their stocks which reduces the price per share. The capital holding of existing shareholders remains the same while the number of outstanding shares increases. Stock splits do not alter the market capitalization, rather the shares become affordable which in turn increases liquidity.
• Exercise Control: As buying shares of a company makes you a part-owner, you might get voting rights for that company. Some classes of shares, such as preferred shares, may not offer voting rights to the investors.
• Diversification of Risk: Investing in equities of different sectors and industries can help investors diversify their portfolio risk.

Even though equity investments have several benefits, there are a few limitations, which are mentioned below:

• Price Fluctuations: The price of an equity share can fluctuate during a trading day and from one day to another. Equity investments are subject to market risks; hence, market fluctuations can impact the return on investments (ROI). Investing in the equity market should be done with caution and funds that might be needed at a short notice or for meeting any short-term financial goals should not be invested in the equity market without proper research and analysis of the underlying equities or market behavior.
• Dividends Are Not Fixed: There is no guarantee of the amount of dividend a shareholder may receive. Some companies may not even give dividends to their shareholders. Only the management (Board of Directors) of the company may decide when and how much dividend needs to be given.

How to Begin Investing in Equity?

Before investing in equities, investors need to keep the following things in mind:

• Open a Brokerage Account: You need to open an investment brokerage account to buy/sell the shares of your choice. You can place the buy/sell orders via the online apps/portal or choose to place the orders offline by contacting the financial institution.
• Research: Investors need to conduct a thorough research about the individual share and the share market before investing. Investors can check the present financial health of the company, look into the current management, check the future vision as well as the roadmap of the company before considering adding the shares of that company into their portfolio.
• Analysis: Investors need to keep a track of the fundamental and technical aspects of the shares, such as profit and loss statements, company balance sheets, cash flow statements, among others, before investing.
• Track the Portfolio: Along with creating a diversified portfolio, by investing in shares of different sectors, investing in different financial products, among others, investors also need to keep a track of their portfolio on a regular basis.

Frequently Asked Questions

How do equity investors get paid?

Equity investors can get paid through two common ways, i.e., share price appreciation and dividends. If the price of the equity share increases in value, i.e., when the current price is more than the buying price, investors who sell their holdings can get potential profits. Also, some companies may offer regular dividends to the investors while some companies may or may not offer dividends, the decision of which lies with the Board of Directors.

What are the different types of equity investments?

Equity investments include a basket of investment options. Some of them are mentioned below:

• Shares
• Equity Mutual Funds
• Equity Derivatives (Futures and Options)

Disclaimer:

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