Equity Investment Meaning
Equity investment is buying shares directly from companies or other individual investors with the expectation of earning dividends or reselling the same to make gains when the prices are high. Investors can increase their profits as the value of equity investment rises.
An investor buys the shares on a stock exchange market while trading at a lower price. They monitor the shares’ performance at the stock market, and when the share price goes up, they sell them at a profit. Equities bring about more diversification in the asset allocation of a portfolio.
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Key Takeaways
- Equity investment is buying shares directly from companies or other individual investors with the expectation of earning dividends or reselling the same when it is profitable.
- Examples of equity investment include equity mutual funds, shares, private equity investments, retained earnings, and preferred shares.
- An equity investment offers the investor multiple benefits like risk spread, easy transfer, profitability, and easy monitoring.
Equtiy Investment Explained
Equity investment allows investors to make huge profits in a frequently changing market. Though the profits are generated faster, the risk element is also quite high. Once an investor decides to make an equity investment, they must approach a broker or a financial advisor who helps facilitate smooth trading. Trading is the process of buying and selling shares at the stock money market.
The stock marketStock MarketStock Market works on the basic principle of matching supply and demand through an auction process where investors are willing to pay a certain amount for an asset, and they are willing to sell off something they have at a specific price.read more allows investors to buy and sell stock securities. The existence of these markets is a guarantee to investors that their interest in stocks payout when need be.
The rising and falling of share prices regulate when to buy or sell your shares. When the prices are low, one should purchase the shares and sell them when the price goes up. When the investor invests, they will hold part of the company’s ownership. The investment helps the company to expand and create a more profitable business.
Keeping in mind the background of companies one wants to invest in helps the investor understand their performance and make an informed decision without risking their money to non-performing companies.
There are ups and downs of equity investments, and availing the service of a financial advisor can keep one safe. Therefore, it is important to analyze the company of interest’s performance in stocks in the past few years. In addition, holding shares for different companies helps cushion the investor against risk.
Types of Equity Investment
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The following are some of the most common types of equity investment;
#1 – Common Shares
- Partial ownership of company units is commonly known as shares, and the investor is called a shareholderShareholderA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares.read more. Each shareholder receives the profits made in the company in proportion to their shareholding. The stock exchange market where the companies are listed trades shares. For example, the New York Stock Exchange is an American exchange market. It is the world’s highest stock exchange market with a $30.1 trillion capitalization. The performance of the company determines the value of its shares.
- It is important to note that shareholders have voting rights to the decisions made in the company. People with more shares hold more voting power.
#2 – Equity Mutual Funds
- Equity mutual funds are pools of money from multiple investors invested in the equity shares of different companies. These are meant for those investors who have limited knowledge in trading and have less time to do research. Equity mutual funds can be divided into large-cap, mid-cap, and small caps based on market capitalizationMarket CapitalizationMarket capitalization is the market value of a company’s outstanding shares. It is computed as the product of the total number of outstanding shares and the price of each share.read more. They offer the benefit of professional supervision and asset diversification. They also offer higher transparency and the opportunity to invest in smaller amounts through SIPs.
#3 – Preferred Shares
- These are almost similar to common shares but with no voting rights. Dividends get paid annually. Where a company fails to declare its annual dividends, it will pay a cumulative amount. Preferred shareholdersPreferred ShareholdersA preferred share is a share that enjoys priority in receiving dividends compared to common stock. The dividend rate can be fixed or floating depending upon the terms of the issue. Also, preferred stockholders generally do not enjoy voting rights. However, their claims are discharged before the shares of common stockholders at the time of liquidation.read more have a higher priority and claim on dividends than common shares.
For example, Company XYZ declares $10 cumulative dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more. Bob did not receive payment for three years. In the fourth year, he will receive $40 (4 years multiplied by $10)
#4 – Retained Earnings
Upon issuance of dividends, a company retains some of the dividend payouts for future investments. They are recorded under Shareholder’s EquityShareholder's EquityShareholder’s equity is the residual interest of the shareholders in the company and is calculated as the difference between Assets and Liabilities. The Shareholders' Equity Statement on the balance sheet details the change in the value of shareholder's equity from the beginning to the end of an accounting period.read more. Retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company.read more increases when the company makes profits. The company may prefer to use these earnings to finance its growth.
#5 – Private Equity Investment
Private EquityPrivate EquityPrivate equity (PE) refers to a financing approach where companies acquire funds from firms or accredited investors instead of stock marketsread more is gained from highly-net worth individuals. These investors directly invest in private companies. These companies do not trade publicly and are not listed in stock exchangesStock ExchangesStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ.read more. Often, private Equity aims at achieving a company’s influence and pre-listing them from the market.
Why Should you Invest in Equity?
Investing in Equity favors long-term wealthWealthWealth refers to the overall value of assets, including tangible, intangible, and financial, accumulated by an individual, business, organization, or nation.read more creation. The main objective of any investment is to increase the value of capital invested. Wealth growth is a significant push to investment, which grows the investor’s money in the long run. Therefore, capital gains and dividends are key reasons for an equity investment.
Shares earn dividends and interests, which are paid annually. The investor can also add more shares when prices are favorable or sell their shares when they increase. When a company decides to increase its capital, the existing shareholders can make it again by investing in the right shares.
Equity investment can generate very high returns at a faster rate. However, it is prone to market fluctuations and, therefore, highly risky. With the aid of proper financial advisors, it is a lucrative business that suits people looking for long-term investment.
Advantages
#1 – Risk Spread
An investor can choose any equity market that fits their interest. Investing in different companies is easy and less risky than putting all your investment in one company.
#2 – Easy to Transfer
Shares are liquid and easy to pass ownership to another investor. In addition, new or existing shareholders can increase their shareholding any time they are in the market. So, when the share price rises, brokers or financial advisors can transact at any time.
#3 – Dividends and Interests
As a shareholder, there is an entitlement to yearly dividends and interest. Dividends form part of the return on investment (ROI). Each share earns a given percentage of interest.
#4 – Profitability
Profits yield from capital gain is much higher in equity investments than other investments. The share purchase price versus the market price determines the amount of gain one gets. As the market gets stronger, the shares gain more.
#5 – Easy to Monitor
Having a broker or an advisor will facilitate easy monitoring. They will ensure that transfer and purchase are done in real-time. Any settlement that is required can also be done within the stipulated time. Time is of the essence while trading in shares.
Frequently Asked Questions (FAQs)
When an investor decides to invest in an equity investment, they get part of the company’s ownership. They receive a percentage of the profits or losses of the company. The company may use the capital to drive its growth and expansion.
A person needs to verify their KYC (Know your customer) verification first. Then, they can hire a brokerage firm to start investing in the stock market. Or they can avail the guidance of an experienced financial advisor. They can also buy equity funds from a fund house.
Private Equity is an alternative asset class where a person invests directly in a company. This money is often used to reset or revamp a company by funding expansions. They are not traded publicly in stock exchanges. These are more suitable for experienced investors who are in it for the long haul.
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