Equity shares have the potential to yield high returns and are one of the most common investment options. Investors can trade shares of listed companies on stock exchanges like NSE and BSE.
Here’s an example of how profits are made via equity shares:
Mr. Singh invested Rs. 10,000 in a few Nifty 50 stocks in 2011. By 2020, the investment saw an 8.81% compounded annual growth and rose to Rs. 23,264.
Understanding how shares yield income is crucial for learning why companies issue shares to fund their growth.
What Are Equity Shares?
Equity shares are percentages of ownership in a company. Such shareholders have voting rights, and thus, they can select an organisation’s management. A company can choose to fulfil its capital requirement by raising funds from the public. They have to issue shares or sell existing shares via an initial public offering (IPO).
Post listing, investors can trade these shares on a stock exchange to make financial gains. A shareholder is entitled to the company’s profits and therefore adds to its growth.
Companies, in return, share these profits with their shareholders in the form of dividends.
Except under liquidation, a company is liable to pay back the accumulated capital to its holders.
Features of Equity Shares
Investors consider equity shares a popular investment tool. Some of their most salient features include the following:
- Permanent and high-yielding: Equity shares are valid until the company shuts down. Thus they are non-redeemable and are the company’s permanent assets. Additionally, shares have a high return generating potential. Since they directly reflect the company’s valuation, they are volatile and risky.
- Transferable: Unlike most financial assets, equity shares of a company are transferable to other investors.
- Dividend payout: Companies can choose to pay dividends from their annual profits to their shareholders. Since shareholders are legal partners, they can also be a part of their profits. However, companies are not liable to share their profits, and thus, the dividend payout depends on their surplus cash flow situation.
- Liquidity and voting rights: From an investor’s perspective, shares are more liquid than other assets like real estate. Investors can trade these shares during trading hours and quickly convert them into cash. Also, equity shareholders have voting rights and can affect a company’s governance.
How Do Equity Shares Work?
Equities are synonymous with a company’s ownership. When investors own shares, they hold them as a proportion to the company’s total outstanding shares.
Companies require capital to sustain their growth. Moreover, depending on the company’s projected scale and scope, they need substantial equity share capital for its operation. So instead of hiring financiers who can sponsor their operation alone, companies choose to float their shares in the market via an IPO.
While debt financing is another solution to raise capital, companies owning lesser tangible assets may find it challenging to pledge them for a loan.
Once the company lists its shares on the stock exchange, its share price fluctuates. The fluctuation indicates that investors value the company’s shares differently.
The Various Types of Equity Shares
Here are some of the different types of equity shares:
- Authorized share capital refers to the maximum capital amount that companies can raise. Depending on their demand for working capital and valuation, companies can choose to increase the permissible limit.
- Issued share capital: Issued share capital represents the shares companies issue to their potential investors via an initial public offering.
- Subscribed share capital: This represents the portion of issued share capital that investors agree to and invest in.
- Right shares: Right shares aim to safeguard a company’s ownership, and companies issue them to investors after they have invested in the equity shares. These shares give investors a chance to choose the company’s governance.
- Sweat equity shares: These are rewards companies offer their investors as a token of appreciation.
Other forms of equity include part of the subscribed share that the company reinvests (paid-up capital) and those issued as dividends (bonus shares).
Why Should You Invest in Equity Shares?
Investors allocating funds to equity shares can enjoy the following benefits:
- Diversification: Investors can invest in equity shares of multiple companies across different sectors. This portfolio diversification helps investors minimise financial risk.
- Creation of wealth: Equity shares have the potential to generate substantial returns over the long term. Thus, investors seeking capital generation can consider investing in equity.
- Liquidity: Equity shares have high liquidity. Investors can sell their holdings during trading hours to meet any urgent financial requirement.
- Regulated and tax-efficient: India’s capital market regulator, SEBI, provides all guidelines about equity shares. The rules ensure that investors’ funds and information related to stocks remain secure.
Also, investors enjoy tax benefits on equity shares investment. For long-term capital gains, investors get tax exemption for up to Rs. 1 lakh. Gains exceeding Rs. 1 lakh attract LTCG tax of 10%. That said, short-term capital gains are subject to 15% tax.
Limitations of Equity Shares
Equity shares help yield high returns for investors on a long-term basis. However, there are certain limitations that equity shares present:
- Equities can only help investors reap benefits when one stays invested for a substantial period. Short-term investors who expect steady returns may not find it feasible to invest in equities.
- Equity share cost per unit is higher than the cost of raising other funds.
- With gradual growth, companies may add more equity shares that lower the earning capacity per investor.
Steps to Buy Equity Shares
Follow these steps to purchase equity shares:
Step 1: Get a Pan Card
It is necessary for you to obtain a Permanent Account Number (PAN) in order to invest in the stock market and purchase shares. The PAN is a primary prerequisite for assessing an individual’s tax liabilities, it is a unique 10-digit Alpha-Numeric number assigned by the Tax Authority.
Step 2: Find a Good Broker.
Finding a broker is the second. It is not possible to trade on the stock exchange without the assistance of an intermediary. There are many firms that offer trading services, but you should choose one that is registered and licensed by the Securities and Exchange Board of India (SEBI).
Step 3: Get a Demat and Trading Account.
You will need a Demat and Trading account once you have a broker. Shares can’t be held in physical form, they have to be dematerialized, so a Demat account handles that for you. You also need a Trading account to buy and sell shares. Most brokers handle the entire process for you.
Step 4: Depository Participant.
Choosing a depository participant is the fourth step in buying shares. The shares purchased by you will be held by the Depository Participants, and those you sell will be released by the Depository Participants. In India, there are two depositories: NSDL and CDSL (Central Depository Services Limited).
Step 5: UIN – If You Want to Invest Huge Amounts
If you are planning to invest large amounts of money, for example, if you want to trade for more than Rs.100,000 at a time, you will need a UIN or Unique Identification Number.
Final Word
Individuals can consider investing in equity shares to fulfill their financial objectives, for example, building a retirement corpus. That said, before allocating their savings to stocks, one must understand all the necessary details regarding them.
Frequently Asked Questions:
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Can an individual invest in equity stocks during inflation?
Experts believe that equity shares are decent investment opportunities with or without inflation. When the inflation rate is high, corporate companies can make profits on their products. Hence their share prices can go up. Consequently, companies can benefit from the low-interest rates when the inflation rate is low.
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Are bonds riskier than equity funds?
Bonds are associated with lower risk than equity funds because they are fixed-income instruments. However, they are less rewarding than equities which can multiply overnight.
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What are some demerits of equity stocks?
Investment in equity shares is time-consuming since one must do thorough research and analysis before investing. Furthermore, they are high-risk financial instruments that do not provide steady fixed income.
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