Equity shares are a common type of security that acts as evidence of ownership of a share in a company. Learn more about their features, advantages and more with Research 360.
One of the most important asset classes that you need to be aware of as an investor is equity shares. If you have market-linked investments in your portfolio, chances are, you may already be acquainted with this asset class. Nevertheless, having equity shares in your portfolio and making the most of these investments are two different things — and the right kind of knowledge can help bridge this gap.
So, to help you make the most of your investments in equity shares, let’s take a deep dive into this asset class. In this article, you’ll get to know more about the meaning of equity shares, their features, the general advantages of equity shares and their risks.
What are Equity Shares?
Equity shares represent units of ownership in a company. Companies raise capital for their business operations by issuing equity shares to interested investors via an Initial Public Offering (IPO). The funds raised in this manner are then used to further the business requirements of the company.
For investors, each equity share held represents a unit of shareholding in the company. The more equity shares you hold in a company, the higher the shareholding percentage will be. Fundamentally, this sums up the meaning of equity shares.
Key Features of Equity Shares
There are some distinct features of equity shares that set them apart from various other asset classes. Check out these defining characteristics below.
Voting Rights to Shareholders
Equity shareholders are essentially partial owners in a company. So, these shares give shareholders the right to vote on various business matters in the general meetings of the company. You can attend these meetings and exercise your voting rights as an equity shareholder.
Eligibility to Receive Dividends
Profitable companies may often distribute a portion of their profits to shareholders in the form of dividends. The dividend is typically declared at a fixed rate per equity share. So, the higher the number of equity shares you hold in a company, the higher the dividend earned.
Tradeability
Equity shares are permanent and irredeemable. However, they can still be traded by investors in the secondary market via stock exchanges like the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). This allows you to exit your position if needed.
Potential to Generate Returns
Equity shares are traded in the secondary market, as outlined above. The prices of these shares tend to fluctuate over time. Traders and investors can take advantage of this characteristic feature of equity shares to earn potentially high returns over the long term.
Types of Equity Share Capital
The equity share capital of a company can be divided into three primary categories, as outlined below.
Authorized Share Capital
This is the maximum amount of share capital that a company is legally authorized to issue to its shareholders. This limit is specified in the company’s incorporation documents like the Memorandum of Association and Articles of Association. If a company wishes to increase its authorized share capital, these documents must be amended after the necessary resolutions are passed by the company’s shareholders.
Issued Share Capital
This is that portion of a company’s authorized share capital that has been issued to shareholders. It represents the total value and/or number of shares that are in circulation among the company’s existing shareholders.
Subscribed Share Capital
The subscribed share capital is that portion of a company’s issued share capital that shareholders have subscribed to. In other words, this is the share capital that shareholders have agreed to acquire or purchase.
Paid-up Share Capital
The paid-up share capital is that part of the subscribed share capital that investors have fully paid for. This indicates the amount of capital raised by the company for its business operations.
Types of Equity Shares
There are different types of equity shares in the financial market, each with its distinct features and benefits. Check out the main types of equity shares you can add to your investment portfolio today.
Bonus Shares
These are additional equity shares that are issued by a company to its existing shareholders at no cost. As the name indicates, these are bonuses or rewards offered by a company to its current shareholders. Bonus shares are generally issued at a specified ratio for each existing equity share. For example, a 1:2 bonus share issue indicates that one additional bonus share will be issued for every two shares you already hold in that company.
Rights Shares
Rights shares are additional equity shares that are offered to existing shareholders in proportion to their current shareholding. While they are not offered free of cost like bonus shares, they are generally issued at discounted prices. This allows you, as an existing shareholder, to increase your shareholding in the company by buying shares at favourable prices, at a discount to the prevailing market price. As the name indicates, you can choose to exercise your right to purchase these shares at your convenience and financial requirements.
Sweat Equity Shares
Sweat equity shares are issued by companies to their employees at discounted prices or even free of cost. They may be offered as a type of compensation for the services, expertise or intellectual property contributions made by the employees. These shares typically have a vesting period or a lock-in period, after which employees gain access to the right offered by these equity shares.
The Advantages of Investing in Equity Shares
There are various advantages to including equity shares in your investment portfolio. If you are contemplating the idea of increasing your exposure to equity investments, check out how this move can benefit you.
Capital Appreciation
Equity shares may offer the advantage of capital appreciation, which means the value of the shares can increase over time. As the business of a company becomes more profitable, the demand for its shares may increase, leading to an increase in share prices. If you hold equity shares over the long term, you can benefit from this capital appreciation by selling the shares at a higher price than what you initially paid, thereby earning a capital gain.
Dividend Income
Many companies distribute a part of their profits to their shareholders. This is known as a dividend payout. By investing in equity shares of companies that regularly pay out dividends, you can earn dividend income based on the company's financial performance and dividend policies. Dividends also provide a regular stream of income for you, which can be particularly attractive if you are seeking income-oriented investments to supplement or replace your primary source of income.
Hedge Against Inflation
Inflation is the phenomenon that explains the decreasing purchasing power of money. This means that over time, the cost of living increases. Equity shares can serve as a hedge against inflation, which erodes the purchasing power of money over time. They have the potential to outpace inflation by providing higher returns. By investing in this asset class, you may have the opportunity to protect your investments against the eroding effects of inflation and potentially achieve significant real returns.
Portfolio Diversification
Equity shares offer an avenue for portfolio diversification. By investing in a variety of companies across different sectors and regions, investors can spread their risk and reduce the impact of any individual company or industry-specific downturn. Diversification can help balance the overall risk-reward profile of an investment portfolio, as different companies may perform differently in various market conditions. Equity shares can thus contribute to a well-diversified investment portfolio and potentially enhance its overall performance.
The Risks of Investing in Equity Shares
On the flip side, there are also some risks of investing in equity shares. Being aware of these risks can help you factor them into your investment plan. So, check out the key risks that you need to watch out for before investing in equity shares.
Market volatility:
This risk stems from the fact that share prices can fluctuate significantly in response to various factors such as economic conditions, market sentiment, geopolitical events, or company-specific news.
Company-specific risks:
Individual companies may also face specific risks that affect the performance of their shares - like poor financial performance, management changes, competitive pressures, technological disruptions and legal or regulatory challenges.
Loss of Capital:
This risk occurs if the share price of a company declines significantly or the company faces financial difficulties, as a result of which you may experience a loss on your investment.
Liquidity Risk:
Some equity shares, especially those of smaller companies, may have limited liquidity. You may find it difficult to buy or sell shares in such companies at the prices you prefer, particularly if the market is already moving in an unfavourable direction.
Systemic Risks:
Equity markets are subject to systemic risks that can impact all companies and their share prices. These risks can be economic recessions, financial crises, political instability, or changes in government policies.
Conclusion
This sums up the fundamentals of the meaning of equity shares, the types of such shares and the benefits of investing in them. Now that you are aware of these key details, you can create a financial plan to include equity in your investment portfolio. On the other hand, if you have already invested in equity shares, you can use your newly acquired knowledge of this asset class to further benefit from the advantages of equity shares.
