What Are Equity Shares
Equity shares are the long-term and prime source of financing for any company. These shares are issued in the share market to the general public and are non-redeemable. Equity shares do not offer a fixed rate of dividend to the shareholders. Such shareholders are the actual owner of the company because the equity is the part or stake of the company and the shareholder who holds a particular percentage of equity becomes the owner of that stake.
Characteristics of Equity Shares
Various characteristics of equity shares are as follows:
- Voting Rights
Generally, most of the equity shares give voting rights to the shareholders which let them allow to choose an individual to run the business. If the shareholders elect an efficient and responsible manager then it helps the company in increasing its turnover which further increases the investors' average dividend income.
- Realization of Additional Profits
Equity shares allow the shareholders to realize the additional profits, if any, generated by the company during a fiscal year. This helps the equity shareholders in increasing their total wealth.
- Permanent in Nature
Equity shares are non-redeemable and permanent. It means a shareholder can't return these shares until the wind up of the company.
- Transferable and Dividend Pay-out
The ownership of equity shares can be transferred by a shareholder to other investors. Other than this, many companies offer dividend pay-out to their equity shareholders. The amount of this dividend may affect the company's profit and the funds available to the company. So, if a company is failing to generate profits then it can hold on to dividend pay-out.
- Potentially High Returns
Equity shares are volatile and they have a high-risk factor. But as we know, 'higher the risk is, higher the possibility of profit'. This golden principle applies in the case of equity shares also. So, when a company generates higher profits, investors also enjoy more dividends.
- Limited Liability
The liability of the equity shares is limited only to the extent of the shares.
Types of Equity Shares
As per Section 43 of the Companies Act, 2013, there are the following types of equity shares that a company can issue:
1. As per the Definition
- Bonus Shares
These are the shares that the company issue to the existing shareholders without any charges to pay their dividend to:
- Capitalize the retained earnings of the company or a part of them.
- Distribute treasury bills.
- Convert the share premium account of the company.
- Rights Shares
These are the shares that the company issue to the existing shareholders at a particular price that is less than the market value of the shares within a specific period. Such shares are first offered to the existing shareholders and then are offered in the share market only if the shareholders do not buy them. Rights shares can be further divided into two types:
- Direct Rights Shares
- Standby or Insured Rights Shares
- Sweat Equity Shares
These are the shares that the company issues to its existing employees or directors to motivate or encourage them for their extraordinary contribution to the business or a project. Here, this contribution is not only related to the monetary benefits but is also about the physical labor, mental efforts, time contributed, etc. of an individual.
- Non-voting Shares
Such types of equity shares do not give voting rights to the shareholders. That's why these shares are also known as differential or zero voting rights shares. These shares are issued at lower prices in comparison to the voting shares.
2. As per the Returns
- Dividend Shares
Dividend shares are the shares that the company issue on a pro-rata basis to make the payment of shareholders' dividends.
- Growth Shares
These shares are issued by the company with a very high rate of growth. Such companies rarely distribute their profits in the form of dividends and keep them in the form of retained earnings for the further growth and diversification of the business. The market value of such shares increases very rapidly.
- Value Shares
These shares are issued in the stock market at the price lower than their intrinsic value. Value shares have a high dividend yield, low P/B ratio, and low P/E ratio. Such shares show the performance of a company in the marketplace.
Various Prices of Equity Shares
- Par or Face Value
It is the value that is recorded in the company's books of accounts.
- Issue Price
It is the price that is offered by the company to the investors in the share market. Mostly in the case of new companies, both face value and issue price are the same.
- Shares at Premium
When a company issues its shares at a price higher than the face value of the share then it is known as shares at a premium. The amount of premium is calculated by subtracting the face value from the price of the issue of shares at a premium. Generally, a company with a higher profit issues its shares at a premium because of the high demand.
- Shares at Discount
When a company issues its shares at the price lower than the face value of the shares, then it is known as shares at discount. The discounted price is the difference between the face value and the prices of shares issued at discount. Generally, a company issues shares at a discount when it urgently requires the money.
- Book Value
The balance sheet value of the shares is called the book value. This value is important in the case of mergers and acquisitions. It can be calculated as follows:
[Paid-up Capital + Reserves and Surplus - Loss (if any)] / Total Number of Equity Shares Issued by the Company
- Market Value
It is the price at which the shares are currently sold in the market by the companies which are listed on the stock exchange. It is also known as the stock market value of the shares. The market value and value as per fundamental principles can be different because the market value is affected by various sentiments.
- Fundamental ValueMbr>
Intrinsic or fundamental value is the true value of the shares, i.e., the maximum value at which a company can sell its shares. It is the price at which a rational investor is willing to invest in the company's shares. Fundamental value can be calculated by using:
- Dividend Discount Model
- Earning Capitalization Method
- Price Earnings Ratio
- Chop Shop Method
How to Buy Equity Shares?
There are the requirements of the following accounts to invest in the equity share:
- Demat Account
A Demat account is required to hold the shares or securities in electronic form.
- Trading Account
A trading account is required to buy or sell the shares and place orders. Also, the account should be registered with a stock brokerage firm.
- Linked Bank Account
The investment in the equity market can be done through IPO or secondary stock market. For both these purposes, you need a linked bank account.
An investor can buy the equity shares in the following two ways:
1. Via IPO
IPO refers to the Initial Public Offers. When a company issues its shares for the first time, before getting listed on the exchanges then it is known as IPO. Via IPO, the companies open their doors for the public investors to buy their equity shares. An investor can place bids for an IPO through stock exchanges or can use the means of a net banking account.
2. Via Stock Market
If you missed buying the shares via IPO then you can buy them once the company gets listed. You can follow the given steps to invest in the equity through the stock market by using a trading account:
- First of all, open all the necessary accounts that are needed for the investment in the equity shares through the stock market such as a Demat account, trading account, and a linked bank account.
- Research about the company in which you want to invest your money. Closely analyze the growth, profit, dividend policy, etc. for this purpose. Once you decided, log in to your trading account and select the shares that you want to purchase.
- After completing the transaction, you can place the order and the shares will be immediately credited to your Demat account in electronic form.
Advantages of Equity Shares
A large base of equity capital helps in increasing the creditworthiness of the company among the investors as well as the creditors. This is further beneficial for the organization in raising funds whether through equity or debt.
- No Interest
The companies do not have to pay any fixed amount to the investors in the form of interest on their investments in the equity shares. This makes it beneficial for the company as the companies are not bound to distribute their profits.
- No Obligation
The investors can't oblige to pay dividends. It is completely based on the choice of the company whether it wants to retain the profits or distribute them as dividends.
- High Income
The equity share market is an important part of the capital market which provides a remarkable source of income to the investors. These securities not only support the wealth creation through capital appreciation but also help the investors in getting higher dividends or can say the return on the investment.
Liquidity is the volume of shares that are traded on a stock exchange. Equity shares are highly liquid. It means a shareholder can easily sell them on the exchange whenever he/she wants to generate some cash from them.
- Easy and Efficient
Investing in the equity shares of a company is a very easy task. For this purpose, an investor can take the help of a stockbroker or financial planner. Then, the investor can invest his/her money in the company that is suggested by the broker after opening a Demat account. This account allows the investors to make easy and efficient transactions while buying the shares.
- Hedge Against Inflation
With the help of asset value appreciation, an investor can increase his/her standard of living but only if the investment is made in the profitable equity shares. Such investment gives manifold returns, a higher rate of erosion of an individual's purchasing power due to inflation. Thus, it leads to an increase in the real value of investments over time.
- Portfolio Diversification
Those investors who can't take more risk with their investment terms stick with debt instruments due to their less volatility. However, there is an inverse relationship in the fluctuations of the share and bond market when it comes to aggregate demand. Thus, in case of underperformance of the bond market, risk-averse investors can earn profit by investing their money in the best equity shares, i.e., equity shares with a higher return, via stock market investments.
Disadvantages of Equity Shares
- No Takers
A company can invite investors to invest in the company by buying equity shares. But it means not that the company will get the investors. Investors are highly rational these days. They have enough knowledge of the share market functions and fluctuation. Now, an investor closely analyzes the data before investing. In such a case, if the shares issued by the company do not satisfy the investors' expectations or requirements then there is the possibility of no investment in the company's shares. So, if there will be no buyers then the company will fail to raise capital.
- Insufficient Capital Generation
Even if a company manages to attract enough shareholders, it is not necessary that the company will be successful in generating sufficient capital. The investors have various options of equity shares in the stock market. This huge availability of options becomes a hurdle in the path of equity share capital generation which can also make the issuing shares ineffective.
- Higher Liabilities
When a company issues its shares at discount then it may get a larger number of investors. This larger number of investors can be meaningful and beneficial only if the company can manage such number of shareholders. Otherwise, these shareholders will become the liability for the company as a huge part of the profit will be transferred to them in the form of dividends. An increased liability burden fails the idea of raising equity share capital and it is also a drawback for the company's sustainability.
- Highly Volatile Market
In the stock market, the market of equity shares is highly volatile because it can change even with some minor fluctuations. The market can get affected by sentiments, social, political, or any other reason. So, if an investor buys the shares at the time when the prices are highest then he/she can suffer loss. However, the case of purchasing shares at the time of low prices can generate profits also for the investors. But at the time of recession or market downturn, the equity share market can get adversely affected. Such volatility is one of the major problems of the equity shares market.
- No Returns
The equity shareholders get their return only after the payment of all other obligations by the company. The profit of a business gets reduced due to the affected business cycle at the time of market downturn. In such a case, the company uses its limited profit to pay its all existing liabilities before disbursing the funds to add returns on equity investment. So, there is also the possibility of no returns in a particular year due to the unavailability of the funds, or maybe the company wants to invest the profit in the growth and development of the business. It is a huge drawback for those shareholders who expect a regular and high dividend from the company.
- Capital Loss
The prices of equity shares are determined by the factors of demand and supply of the company's shares in the share market. If the investors find that the company will grow in the future and will generate higher returns then they will buy more shares. When the shares are bought on a large scale then it may give rise to the prices of the shares. On the opposite side, if the investors predict that the company will not grow in the future due to its poor performance or any other factor then they may decide to sell all the shares. This will decrease the demand for the company's shares in the market and further may affect the prices of the shares negatively. So, such a situation may cause capital loss to the investors due to a downfall in the demand.
Calculation of Equity Share Capital
- Formula 1
Equity share capital or shareholders' equity can be calculated by subtracting total liabilities from the total assets. Numerically, it can be presented as follows:
Shareholders' Equity = Total Assets - Total Liabilities
- Formula 2
The share capital method is also known as the investors' equation. This is another formula for calculating the equity share capital of a company. In this formula, treasury stock is subtracted from the sum of share capital and retained earnings. Numerically, it can be presented as follows:
Shareholders' Equity = Share Capital + Retained Earnings - Treasury Stock
Retained earnings are the sum of the company's cumulative earnings after paying dividends and the treasury stocks are the repurchased shares of the company that are used for potential resale to investors.
Alternative Investment Options of Equity Shares: Debt Securities
- From the Companies' Point of View
Debt is a better option for those companies which do not want to dilute the power and ownership of the company. But a drawback of the debt is that the company has to pay a fixed rate of interest on the funds raised by debt.
- From the Investors' Point of View
Equity shares give the highest returns on total investment to the shareholders in the share market. However, the risk associated with the share market is also very high which makes it interesting for risk-averse investors. But those who don't want to bear higher risk can opt for the alternative of equity shares which is debt instruments. However, the return generated in these securities is also smaller due to the lower risk, which decreases the chances of substantial capital gains.