What are Equity Shares? Formula, Features & Advantages

Introduction

A company, while looking to raise capital, has two basic sources of capital it can consider. It could take on debt, wherein it borrows money from lenders through a variety of debt instruments such as debentures that allows them to raise money from the public; or, it could raise money through equity i.e. by issuing shares. Here, the firm trades part ownership of the firm with investors in exchange for their capital. There are a number of types of shares, from preference shares to equity shares. In this article, we will aim to better understand equity shares, how they function, pros and cons of acquiring equity shares as well as some equity share strategies.

What are Equity Shares?

Equity shares are defined as long-term financing options for firms looking to raise capital. Each equity share represents a unit of part ownership in the company. Equity shares are also referred to as common stock, or common shares, and are offered as an investment opportunity to the public.

To compute Equity Shares, use the formula:

Equity Shares = Equity Capital / Face Value per Share

For example, if a company generates ₹5,00,000 from shares with a face value of ₹10, the calculation is 5,00,000/10, yielding 50,000 equity shares. This metric signifies the total ownership units issued by the company. It’s essential to note that market conditions can influence the actual market value of these shares, and investors often consider additional indicators like Earnings Per Share (EPS) and Price-to-Earnings (P/E) ratio for comprehensive analysis.

Ordinary Shares: Ordinary shares are a primary vehicle for companies to secure long-term funds, granting investors ownership benefits and substantial voting rights. Investors with a significant holding of these shares wield considerable influence in various management aspects, contributing to the decision-making processes within the company.
Preference Equity Shares: Preference equity shares, issued with the guarantee of receiving cumulative dividends before ordinary shareholders, lack voting and membership rights associated with common shares. The classification between participating and non-participating preference shares further impacts potential returns for investors based on the company’s performance during a specific financial period.
Bonus Shares: Bonus shares are derived from a company’s retained earnings and give current shareholders with extra stakes without altering the overall market capitalisation. Unlike other equity instruments, bonus shares symbolise the capitalisation of excess funds generated through business operations.
Rights Shares: Rights shares, issued at a discounted price, serve as an invitation to premium investors to increase their stake within a specific timeframe. This strategic approach enables companies to raise the required finances for specific expenditures while maintaining a connection with existing investors.

Features and Advantages of Equity Shares

Unlike saving, investing has higher risk, but gives higher returns and if done properly, takes a shorter time to reach financial goals. Equity shares are considered to be a long-term financing option for companies looking to fund their business operations. For holders of preference shares, there are a number of perks/advantages they can enjoy.

Voting rights:

Arguably the biggest plus point for possessing equity shares is those holders of equity shares are handed voting rights in the form of a say in the election of GMs etc, as well as having a voice in business decisions of the company, since the operations of the company will have a direct effect on the returns they gain from the company. If you possess a large amount of equity shares, you are also granted substantial voting rights.

Admission to meetings:

Those holding equity shares are allowed a seat at any annual and/or general body meetings the company has, alongside a say in the business functions of the family granted to them by their voting rights.

Dividend payments:

Holders of equity shares also qualify for dividend shares. However, here is where there is a difference between the benefits holders of common stock receive when compared to those holding preference shares. Dividend payments to equity shareholders are not fixed and can vary based on the performance of the firm and contingent on it meeting certain goals. Thus, while equity shareholders are eligible to receive dividend payments, these payments are not guaranteed. For preference shareholders, however, dividend payments are fixed.

Equity Shares are Irredeemable:

The money raised from equity shares is not refunded to investors during the lifetime of the company. Equity shareholders can either redeem this capital by selling their equity shares, or will receive it when the company winds up, based on what their equity shares are worth at the time.

Many companies only issue common stocks, and there are more common stocks sold in the exchanges than preferred stocks. However, when a company fails, the common stockholders have the lowest priority when it comes to getting back any of their money. Creditors who have lent money to the company get paid back with top priority. Even if some money is left after paying the creditors, the holders of preferred stocks get paid next. This is subject to a maximum amount. Only if money is left even after that, common stockholders get paid.

What are Preferred Stocks?

There are two main reasons why these stocks are called preferred stocks. Holders of preferred shares receive regular dividends which are higher than those received by holders of common stocks. Preferred stocks pay dividends which are agreed upon beforehand unlike common stocks which pay dividends based on how profitable the company is. One difference between common stocks and preferred stocks is that preferred stocks do not have voting rights.

In some ways, preferred stocks are like a bond. They have a par value based on which the dividend is calculated. Let us say that a preferred stock is worth Rs 1,000 and the dividend is 5 percent. Then the stock must pay Rs 50 as dividend every year as long as the stock is outstanding. When it comes to risk, a preferred stock is riskier than a bond but less risky than a common stock.

Unlike common stocks, prices of preferred stock are not likely to go up by much, even when a company performs well. So, the holder of a preferred stock has fewer chances of making large profits.

Preferred stocks can be of a few types. In the case of convertible preferred shares, you have the option to convert a preferred stock into a common stock. Preferred stocks may also be cumulative. This means that the company may postpone dividend payments when it is not performing well. But when the situation improves, they have to pay the dividends in arrears. This has to be done before any payment is made to common stockholders. Another type is a redeemable preferred stock where the company has the right to redeem the stock at a date in the future.

Important Facts to know about Dividends

Most companies pay an annual or quarterly or even special one-time dividends based on the total profits made during the year.
Income earned from dividends is taxable as per the Income Tax Act, 1961.
Companies can either pay fixed rate, referred to as preferred dividends, or they can pay variable dividends based on the earnings, known as common dividends.
Companies are not obliged to make these payments by any regulatory guidelines.

Dates to Remember

Declaration Date: when the company determines the payment date for the dividend, the ex-dividend rate, and the dividend amount.
Record Date: The companies compile the list of all the shareholders who are eligible to receive the declared dividends.
Ex-Dividend Date: This is often a few days before the record date when pending transactions, if any, are completed prior to the record date.

Benefits of Dividends to Investors:

Dividends provide investors a stable return on their investments, which is low risk. In addition, as the organisations continue to grow, the dividends increase, which raises the value of the stock for the investors. They also allow you to reinvest your dividends.

Investors need to bear in mind that bigger dividends do not always mean better as companies paying high dividends are unable to sustain these rates in the longer period.

The category of companies in the stock market that possess a consistent track record of distributing their profits as dividends to their shareholders are referred to as dividend stocks. Since they’re well-established and have already peaked and matured, these stocks usually have a much lower future growth potential than growth stocks.

Among the category of dividend stocks, there are two primary sub-categories – dividend growth stocks and high dividend stocks. Dividend growth stocks possess a greater potential for future dividend rate increases. On the contrary, high dividend stocks may or may not increase the dividend rates in the future, since they’re already paying out a significantly high rate.

Equity vs Other Investments

Equity requires low investment: Unlike Fixed Deposit, Gold & Real estate, you can enter the equity market with a much smaller capital.
Equity offers higher returns: It is historically proven that Equity offers better returns in comparison to FD, Gold & Real-estate.
Returns on Equity beat inflation & are completely tax-free.
Equity offers high liquidity. Equity can be bought & sold very easily & converted to cash pretty fast.
Equity is the best performing asset class. Equity increases your wealth faster over a long time due to compounding effect, capital appreciation & dividend income.

Insider Trading

It is a malpractice where the traders carry out a transaction based on the non-public or unpublished information they got access to, which can be necessary for making investment decisions.

The three essential elements of insider trading are:

Material non-published or price-sensitive information
The information obtained from an inside source
A trader must have dealt with the securities based on the information obtained

What is the Efficient Market Hypothesis (EMH)?

The efficient market hypothesis assumes that any and all available information related to an asset is already factored into its current price. This effectively means that an asset trades at its fair value, making it impossible to identify undervalued or overvalued stocks.

The efficient market hypothesis essentially states that the market is so efficient that it is capable of quickly factoring the impact of the new information in the prices of the assets. It also states that irrespective of how many analytical techniques you use, as a trader or an investor, it is simply not possible to beat or gain an edge over the ‘market.’

Based on the level of efficiency, markets experience efficiency of three forms – weak, semi-strong and strong.

Risks in Predicting the Equity Markets

As per the Random Walk Theory by Burton Malkeil (1973), beating the market is not an actual mathematical possibility, and there is no sure way of doing it. There are enough scientific studies claiming authentically that prove the lack of predictability (Ball and Brown, Fama, Jensen, Goyal and Welch, Pontiff, Martineau etc) and effective return predictors (Rosenberg, Reid and Lanstein, Campbell and Shiller, Jegadeesh and Titman).

What are the Methods of Equity Trading Prediction?

In the most fundamental level, there are two methods for explaining and prediction of equity value. These are technical and fundamental analysis.

Technical analysis is largely based on analysing past stock behaviour to find out how stocks will react in the future. The idea is to find patterns of behaviours- like ‘head and shoulders’ or ‘wedges’ or ‘triangles’ which help in finding indications of equity markets behaviour. Around 10% of trade analysts use technical analysis according to Burton Malkeil.

Fundamental analysis on the other hand is based on the real life indicators of a company’s health and value. Malkeil suggests the most effective indicators are- its internal expectations of growth, dividend payout and ofcourse its history of price volatility.

How to Buy Equity Shares?

To engage in stock market investments and acquire equity shares, a crucial trio of accounts is necessary. Firstly, a Demat Account is essential, serving as the repository for holding shares in the investor’s name. Secondly, a Trading Account is imperative, allowing the placement of buy and sell orders through a stockbroker registered with a stock exchange. Lastly, a Linked Bank Account completes the trio, facilitating seamless financial transactions.

Different Investment Methods:

IPO Way: When a firm initially goes public, investors can buy equity shares through an IPO. During an IPO, investors can apply for shares via their net banking accounts or bid on the company’s shares on stock markets. This strategy enables anyone to become a shareholder of a firm by making its shares accessible to the public for the first time.
Stock Market Purchase: Besides IPOs, investors can buy and sell equity shares on the stock exchange throughout the year. This entails creating a Demat and Trading account connected to your bank account. After this, you enter into the trading account and select the desired shares after determining the purchase price. Finally, you confirm the transaction and transfer the cash, finishing the process. This allows investors to engage actively in the stock market, react to market trends, and alter their portfolios as needed.

Recession vs Depression

Parameters	Recession	Depression
Definition	A contraction in economic growth that lasts for a couple of quarters to a year	A severe form of an economic downturn that lasts for many years
After effects	People and businesses reduce spending, investments are down	The after-effects are much deeper, wherein investors’ confidence is at an all-time low
Influence	Recession can hurt a specific country or some countries in a region	Depression is felt on a global scale that impacts trade and investments
GDP	Negative GDP growth for two consecutive quarters	A drop in GDP growth by more than 10% in a financial year

FAQs

What is equity share vs share?

Equity refers to the total ownership of the company – it is what remains of the company’s assets once the liabilities are all paid off. Shares are simply a portion of the equity. However, there are types of shares other than equity such as preference shares, advisory shares etc.

Equity Shares – Meaning, Features, Advantages

Introduction

What are Equity Shares?