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Equity Concept of Equity Market
Concept of Equity Market Back
 
What is equity
A company organises money to do business with through borrowings and owners contribution. The owners contribution is called equity capital or simply equity. Equity is accumulation of small, equal amounts against which the company issues certificates, which are called shares, stock or again equity. Shares have indefinite life with a face value, which can be changed if the shareholders decide, and no guaranteed return.
 
Ordinary shares or common stock
These are the stocks or shares for all practical purposes of investing for a common investor. These days stocks can have any face value unlike earlier when Rs 10 or Rs 100 used to be the custom.
 
Companies with high market price for their stocks tend to break them up into smaller pieces to ensure participation of small investors. For example, when Infosys' Rs 10 face value share went up to Rs 13,000, the company split the stock and made the face value Rs 5, enabling the market price of the stock to halve and be more accessible. HLL stock carries an even smaller face value of Rs 1 and its stock currently trades around Rs 225. Then there are stocks like Madras Cement which still carry a face value of Rs 100 and that currently trades at about Rs 4300. Madras Cement trades around 5000 stocks a day whereas HLL trades about a million stocks daily.
 
Preference shares
These shares do not carry voting rights and are not traded on stock exchanges, so they have little relevance to an ordinary investors. Essentially, buyers of preferential stock receive a pre-set dividend before a company can distribute its profit among its owners or holders or ordinary shares.
 
Return on equity
Since 1979-80 till date, Indian stockmarket has returned about 18% to investors on average in terms of increase in share prices or capital appreciation. Besides that on average stocks had paid 1.5% dividend. Dividend is a percentage of the face value of a share that a company returns to its shareholders from its annual profits.
 
Dividend yield
It is the relationship between the current price of a stock and the dividend paid by its issuing company during the last 12 months. It is calculated by aggregating past year's dividend and dividing it by the current stock price. Dividend yield gives one a good idea of what the dividend paid by a company is past year would be worth to an investor who enter a stock now.
 
While dividends can be a good hedge against falling market price of a company's stock, one ought to look vigorously at the company's performance and prospects before basing investment decision on dividend yield. In the past there have been companies that have had high dividend yields but have ceased paying dividends within a year or two of their great dividend years. For example, Crompton Greaves had a dividend yield of 4.5% in 1995 which came down to 2.5 in 1996 as the company cut dividend and since 1997 it has not paid any dividend at all.
 
Capital appreciation
This is what most of the world is in the markets for - buying cheap and selling expensive. That space is divided between three kinds of folks - the investors who intend to stay in a stock for many months if not years and see the worth of their company grow, the speculators who see a stock moving sharply up or down in a few days or weeks and the day traders who buy and sell many times everyday in an attempt to take advantage of every price movement.
 
BEING AN OWNER
Holding a company's stock means that you are one of the many owners (shareholders) of a company and, as such, you have a claim (albeit usually very small) to everything the company owns. Yes, this means that technically you own a piece of machinery, every trademark, and every contract of the company. As an owner, you are entitled to your share of the company's earnings as well as any voting rights attached to the stock.
 
Being a shareholder of a public company does not mean you have a say in the day-to-day running of the business. Instead, one vote per share to elect the board of directors at annual meetings is the extent to which you have a say in the company. For instance, being a Tata Motors shareholder doesn't mean you can call up Ratan Tata and tell him how you think the company should be run. In the same line of thinking, being a shareholder of ICICI Bank doesn't mean you can walk into a local branch and get a loan on the base of your stock ownership.
 
The management of the company is supposed to increase the value of the firm for shareholders. If this doesn't happen, the shareholders can vote to have the management removed, at least in theory. In reality, individual investors like you and I don't own enough shares to have a material influence on the company. It's really the big boys like large institutional investors and billionaire entrepreneurs who make the decisions.
 
For ordinary shareholders, not being able to manage the company isn't such a big deal. After all, the idea is that you don't want to have to work to make money, right? The importance of being a shareholder is that you are entitled to a portion of the company’s profits and have a claim on assets. Profits are sometimes paid out in the form of dividends. The more shares you own, the larger the portion of the profits you get. Your claim on assets is only relevant if a company goes bankrupt. In case of liquidation, you'll receive what's left after all the creditors have been paid.
DEBT Vs. EQUITY
Why does a company issue stock? Why would the founders share the profits with thousands of people when they could keep profits to themselves? The reason is that at some point every company needs to raise money. To do this, companies can either borrow it from somebody or raise it by selling part of the company, which is known as issuing stock. A company can borrow by taking a loan from a bank or by issuing bonds. Both methods fit under the umbrella of debt financing. On the other hand, issuing stock is called equity financing. Issuing stock is advantageous for the company because it does not require the company to pay back the money or make interest payments along the way. The first sale of a stock, which is issued by the private company itself, is called the initial public offering (IPO).
 
It is important that you understand the distinction between a company financing through debt and financing through equity. When you buy a debt investment such as a bond, you are guaranteed the return of your money (the principal) along with promised interest payments. This isn't the case with an equity investment. By becoming an owner, you assume the risk of the company not being successful - just as a small business owner isn't guaranteed a return, neither is a shareholder. As an owner, your claim on assets is less than that of creditors. This means that if a company goes bankrupt and liquidates, you, as a shareholder, don't get any money until the banks and bondholders have been paid out; we call this absolute priority. Shareholders earn a lot if a company is successful, but they also stand to incur losses if the company isn't successful.

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