Equity Shares

Equity shares form the backbone of a company’s capital structure. When an investor buys equity shares, they essentially own a part of that company. Understanding what is equity share and how it works is essential for anyone looking to build long-term wealth through the stock market.

This guide breaks down the equity shares’ meaning, their types, features, and advantages & disadvantages, helping you make informed investment decisions.

What is Equity Shares?

Equity shares, also known as ordinary shares, represent ownership in a company. These are considered instruments that can be traded on stock exchanges, allowing investors to buy and sell them freely. When an investor buys equity shares, they become a part-owner of that business. These shareholders have the right to vote on important company matters, share in the company’s profit through dividends, and benefit from the capital appreciation of their shares over time.

In simple terms, the equity shares' meaning can be understood as the capital raised by companies through the issuance of these shares to investors. These investors become the company's owners, anticipating returns primarily through dividends (a share of profits) or growth in the stock value (capital appreciation).

Equity Shares Example:

Let’s understand the meaning of equity shares with a simple example.

Suppose Company ABC Ltd. issues 1,00,000 equity shares at ₹100 each to raise capital for business expansion. You decide to purchase 500 shares, investing ₹50,000 in total.

If the company performs well and its share price increases to ₹150, the value of your investment rises to ₹75,000. Additionally, if the company declares a dividend of ₹5 per share, you’ll earn ₹2,500 in dividends.

This equity shares example shows how equity shareholders benefit from the company’s growth and profitability. While there’s potential for higher returns, the risk also depends on market conditions and company performance, making equity shares a dynamic investment option.

Features of Equity Shares

Here are some of the key features of equity shares:

1. Ownership Rights:

Equity shareholders are the real owners of the company. By purchasing equity shares, investors gain part ownership and can influence major company decisions through voting at general meetings.

2. Voting Power:

One of the most important characteristics of equity shares is voting rights. Each share usually carries one vote, allowing shareholders to elect directors and approve key business matters.

3. Dividend Entitlement:

Equity shareholders receive dividends, but the amount is not fixed. Dividends depend on the company’s profitability and are declared by the board of directors.

4. Limited Liability:

Shareholders’ liability is limited to the amount they have invested. This means if the company incurs losses, shareholders are not personally responsible for its debts beyond their shareholding value.

5. Transferability:

Equity shares are freely transferable. Investors can buy or sell them easily on stock exchanges, providing liquidity and flexibility.

6. Residual Claim on Assets:

In case the company is liquidated, equity shareholders are paid after all debts and preference shareholders are settled. They have the residual claim on the company’s assets.

7. Long-Term Capital Appreciation:

Equity shares offer the potential for significant capital growth over time. If the company performs well, the value of its shares typically increases, generating wealth for investors.

8. Risk and Reward Relationship:

Equity shares carry a higher risk compared to debt instruments, but they also offer higher potential returns. This makes them suitable for investors with a long-term outlook and moderate-to-high risk tolerance.

Types of Equity Shares

Equity shares can be classified based on ownership rights and privileges or the conditions under which they are issued. Let’s take a look at different types of shares:

A. Based on Rights and Privileges:

1. Ordinary Shares:

Ordinary shares are issued by companies to raise long-term capital for business growth and operations. Investors who buy these shares become partial owners of the company and enjoy rights such as voting in shareholder meetings and participating in key business decisions. The more ordinary shares an investor owns, the greater their voting power and influence in the company’s management.

2. Preference Shares:

Preference equity shares are issued to investors who prefer stable and assured returns. Holders of these shares receive a fixed dividend before any profits are shared with ordinary shareholders. However, unlike ordinary shareholders, they usually don’t have voting rights or direct control over company decisions.

In short, preference shares are ideal for investors seeking steady income, while ordinary shares suit those looking for ownership and long-term capital growth.

B. Based on Issue Conditions

1. Bonus Shares:

Bonus shares are additional shares given free of cost to existing shareholders. They are issued out of the company’s accumulated profits or reserves. For example, if you own 100 shares and the company announces a 1:1 bonus issue, you’ll receive 100 additional shares without paying anything.

2. Rights Shares:

Rights shares are offered to existing shareholders at a discounted price before being offered to new investors. This allows loyal investors to maintain or increase their ownership stake. For instance, a company may offer 1 right share for every 5 shares held, at a discounted rate compared to the market price.

3. Sweat Equity Shares:

Sweat equity shares are issued to the company’s employees or directors as a reward for their exceptional performance, contribution, or innovative work.

These shares recognise effort and loyalty, often given at a discount or for non-cash consideration such as technical expertise or intellectual property.

Advantages and Disadvantages of Equity Shares

Let’s take a look at some of the advantages and disadvantages of equity shares to help you make well-informed financial decisions:

Advantages of Equity Shares

1. Potential for High Returns: Equity shares offer investors the opportunity to earn substantial returns over time. As a company grows and its profits increase, share prices typically rise, resulting in capital appreciation.

2. Dividend Income: Equity shareholders may receive dividends, which serve as a source of regular income. Although dividends aren’t guaranteed, they provide an extra return when the company performs well.

3. Ownership and Voting Rights: By owning equity shares, investors become part-owners of the company. They have the right to vote in general meetings and influence key corporate decisions such as mergers, acquisitions, or board appointments.

4. Liquidity: Equity shares are easily tradable on stock exchanges, allowing investors to buy or sell their holdings whenever needed. This high liquidity makes it simple to enter or exit the investment.

5. Limited Liability: The liability of equity shareholders is limited to the amount they have invested. In case the company faces losses or debts, investors are not personally responsible beyond their investment.

6. Hedge Against Inflation: Equity investments tend to outperform inflation over the long run. As the company’s value and earnings grow, so does the value of your investment, helping preserve purchasing power.

Disadvantages of Equity Shares

1. Market Risk: Equity shares are highly influenced by market fluctuations. Economic changes, industry trends, or global events can cause share prices to rise or fall unpredictably.

2. No Fixed Returns: Unlike fixed deposits or bonds, equity shares don’t guarantee income. Dividends depend on company performance, and investors may not receive any payout in poor financial years.

3. Dilution of Ownership: When a company issues new shares, existing shareholders may experience reduced voting power and ownership percentage unless they buy additional shares.

4. Last Claim on Assets: In the event of liquidation, equity shareholders are the last to be paid, after creditors and preference shareholders. This increases the overall investment risk.

5. Requires Market Knowledge: Successful equity investing requires understanding market trends, financial statements, and company performance. Without proper knowledge, investors may face losses.

Difference Between Equity Shares and Preference Shares

The table below demonstrates the difference between equity shares and preference shares:

How to Invest in Equity Shares?

Here’s a step-by-step guide on how to invest in equity shares safely and effectively:

1. Open a Demat and Trading Account: Start by opening a Demat account (to store shares electronically) and a trading account (to buy and sell shares) with a SEBI-registered broker or bank.

2. Complete KYC Verification: Submit documents like your PAN card, Aadhaar, bank details, and proof of address for Know Your Customer (KYC) verification.

3. Link Your Bank Account: Connect your savings account to your trading platform to enable smooth fund transfers while buying or selling shares.

4. Research and Choose Companies: Study the financial performance, business model, and growth potential of companies before investing. Consider both fundamental and technical analysis.

5. Place Buy Orders: Log in to your trading platform, search for the company’s stock symbol, and place a buy order for the desired number of shares.

6. Monitor Your Portfolio: After investing, track your shares regularly to assess performance and make timely decisions based on market trends and company news.

7. Invest for the Long Term: Equity shares perform best when held for the long term. Staying invested through market cycles can help you benefit from compounding and capital growth.

Conclusion

Equity shares play a vital role in helping investors build long-term wealth and participate in a company’s success. By owning equity shares, you gain both ownership and profit-sharing rights, along with the potential for capital appreciation and dividend income.

While they come with market risks, careful research, diversification, and a long-term approach can help minimise those risks and maximise returns. In essence, understanding what is equity share, its features, advantages, and disadvantages empowers you to make informed investment decisions.

FAQs

1. What are the rights of equity shareholders?

Equity shareholders have voting rights, the right to receive dividends, and the right to inspect company records and financial statements.

2. What is the difference between equity shares and normal shares?

There is no major difference; equity shares and ordinary shares refer to the same type of shareholding that gives ownership and voting rights.

3. How do equity shareholders earn money?

They earn through dividends (a portion of profits) and capital gains (when the share price increases).

4. Are equity shares suitable for long-term investment?

Yes. Equity shares are best suited for long-term investors seeking growth and wealth creation over time.