What Are Equity Shares – Meaning, Types, Features, Limitations and More

Reading Time: 6 minutes


When a company needs to raise funds for its operations or growth, there are different sources of financing available to it. Equity shares are one such source of finance that allows companies to raise capital from investors willing to invest in them. But do you know what equity shares mean? Let’s understand here.

This article covers:

Equity shares meaning -what are equity shares?

Equity shares, also commonly called stocks, are a source of long-term finance for a company. A company issues equity shares to investors in exchange for a part of its ownership. If you invest in the equity share of a company, you own a part of the company and, as such, you get voting rights in the company’s management. Also, the profits earned by the company are distributed among its equity shareholders in the form of dividends.

Why do companies issue equity shares?

Companies issue equity shares for the following reasons:

  • To raise capital: This is the primary reason for the issuance of equity shares. If the company needs funds for mergers and acquisitions, expansion, paying off its debts, or for other reasons, issuing equity shares is the most cost-effective way of raising finance. 
  • Better than debt financing: Debt includes interest payments which is a cost for the company. In case of equity shares, companies distribute dividends and that too only when they earn profits. As such, equity is a better alternative than debt.
  • To gain visibility: Companies issuing equity shares are listed on stock exchanges. This gives them market visibility and also helps them build their market value.
Also Read on FinMedium:  Debt vs Equity: Know What Are the Differences Between Debt & Equity Markets

Why do investors buy equity shares?

Investors who know what are equity shares know that they are lucrative avenues of investment because:

  • They are highly liquid
  • They have a high return potential
  • They promise ownership in a company 
  • They allow investors to participate in the growth of a company 
  • They can act as a hedge against inflation
  • They help in portfolio diversification 

So, if investors believe in a company and its profitability, they invest in its equity shares to own a part of the company and to generate attractive returns from the company’s growth.

Types of equity shares

There are different types of equity shares that you can invest in. These are as follows:

Type of equity share Brief description 
Authorized share capital The maximum number of equity shares that the company is authorized to issue
Issued share capital The number of equity shares that the company has issued
Subscribed shares capital The number of shares which have been subscribed to by investors
Paid-up share capital The portion of share capital for which investors have paid
Rights share Preferential equity shares offered to the existing shareholders at a rate lower than the market value
Bonus share Additional shares issued by the company to its existing shareholders, usually, in the place of dividends
Sweat equity shares Shares issued to employees of the company for their hard work
Voting or non-voting shares Usually, equity shares provide voting rights to investors and are called voting shares. However, in some cases, voting rights might not be offered and such shares are called non-voting shares

Equity shares are also classified based on the investment style. They are:

Type of equity share Brief description 
Dividend stocks Shares that pay a dividend
Growth stocks Shares that reinvest the dividend in the business for growth
Value stocks Shares of companies whose market value is lower but the company’s intrinsic value is high due to strong fundamentals

Features of equity shares

You know what is an equity share but do you know the characterizing features that set it apart from other investment avenues? If you don’t, have a look:

  • They are traded on stock exchanges
  • By investing in equity shares you invest in a company. You are eligible to receive dividends if the company makes a profit. Moreover, if the market value of the company grows, the value of the share grows and you can earn profits by selling the share
  • Returns earned from selling equity shares are taxed as capital gains. The gains earned from selling shares after 12 mth are called long term capital gains. Such gains are tax-free up to Rs 1 lakh. Excess gains, however, are taxed at 10%. Alternatively, if you sell the shares within 12 mth, you earn short term capital gains. Such gains are taxed at 15%
  • There is no maturity date. Equity shares are perpetually owned till the company winds up business
Also Read on FinMedium:  Marico Valuation Excel Model and Intrinsic Value of Shares- BDV

How do equity shares work?

Now that you know equity shares meaning, let’s look at how these shares work. When a company issues equity shares to the common public, it lists itself on the stock market and becomes a publicly-traded company. After the initial subscription through an initial public offering (IPO), the shares are listed on stock exchanges. You can buy and sell shares on the stock exchange. The price of equity shares works on the concept of demand and supply among other factors.

  • If demand is higher than supply, the equity share price rises
  • If demand is lower than supply, the equity share price falls

Investors speculate on the movement of share prices when they trade on the stock exchange. When the company winds up business, the assets of the company are used to pay the equity shareholders after all other debts of the company are paid off.

How to make money by investing in equity shares?

If you know equity share meaning, you can earn attractive returns by investing in it. You just need to pick the right stocks at the right time and then sell them at a better price to earn a profit. Here are some tips and tricks on how you can do that:

  • Understand the stock market and how it works. Know the inherent risks of investing in equity. While equity can give returns, it can result in considerable losses too.
  • Study a company’s growth potential before you invest in it
  • Choose quality stocks that would give appreciation to your investment
  • Be patient in a bear market. The market always pulls itself up. You just need to give it time.
  • Have a long term perspective if you want to earn from equity
Also Read on FinMedium:  Info Edge Fundamental Analysis and Future Outlook

Limitations and risks of equity share

Though profitable, equity shares have their fair share of limitations and risks too. Have a look: 

  • They are risky and very prone to market volatility. If the market falls, share values can drop and you might end up losing your investment too
  • The dividends are not guaranteed and depend on the company’s profitability 
  • When the company winds up, equity shareholders are the last recipients of the company’s assets. If the company does not have sufficient assets, equity shareholders stand to lose out on their investments

Equity can be a good addition to your portfolio for diversification and it can help you earn good returns too. However, before you invest, understand what is an equity share, how it works, the possible risks and limitations. Choose quality stocks and invest only your surplus savings. Gain experience in equity investing before you commit a larger part of your investments to equity. Make an informed choice so that your investment does what it is meant to do , which is yield good returns.

Tickertape

Your go-to investment analysis platform

Tickertape

Latest posts by Tickertape (see all)



Source link

Disclaimer: The opinions expressed in this publication are those of the authors. They do not purport to reflect the opinions or views of the FinMedium or its members. The presentation of material therein does not imply the expression of any opinion whatsoever on the part of the FinMedium concerning the legal status of any company, country, area, or territory or of its authorities. For more info. please read our ToU & Privacy Policy here. If you have any concerns regarding this post, please reach out to us at finmedium@gmail.com

Every Wednesday and Saturday, we send Info-Graphic and FinMedium Weekly Digest newsletters to our 25000+ Subscribers.

Join Them Now!


Ticker Tape

Ticker Tape

Ticker Tape shares useful Data, Information & Content on Indian Stocks, ETFs & Indices.
Please Share Now :)

Leave a Reply

Your email address will not be published. Required fields are marked *