It is really a genuine & a basic question – isn’t it? What do you get if you invest in shares? How shares give returns? PPF & FDs give interest at maturity or periodically but do shares also share anything with an investor? If yes, what is the periodicity? Let’s see the monetary & non-monetary benefits of investing in Shares or Equity or Shares.
Shares are just mere entries in your DEMAT account if you don’t understand the payoff. Shares benefit or give returns in multiple ways.
Importance of shares lies in the fact that equity investments can beat inflation, let’s understand how it can be beneficial to shareholders?
An equity share is a unit of ownership in a company. Every company issues a certain number of shares to its promoters, i.e., those who participate in its formation. The company issues additional shares to the public when it raises money by way of an Initial Public Offer (IPO).
Hence, in addition to the promoters, the public too becomes shareholders of the company.
So, simply if you hold 100 shares of a company which has issued 10,000 shares, you own 1 percent of the company.
Benefits to a shareholder – Why Buy Shares?
Why invest in Stocks? What are the benefits of investing in shares as a shareholder?
Apart from the right to vote and decide the future course of action that a company takes, the real benefit that you, as a shareholder, have is in the form of participation that you get in the profits made by the company. At the same time, your liability is limited only to the face value of the shares held by you.
The benefits distributed by the company to its shareholders can be divided as – Monetary benefits & Non-Monetary benefits.
Monetary Benefits of Investing in Shares
Monetary benefits of investing in shares can be in the form of Dividend or Capital Appreciation.
Dividend
You as an equity shareholder have a right on the profits generated by the company. Profits are distributed in part or in full in the form of dividends.
The dividend is your earning on the investment made in shares, just like interest in case of bonds or debentures. A company can issue dividends in two forms:
- Interim Dividend
- Final Dividend
While the final dividend is distributed only after the closing of the financial year; companies at times declare an interim dividend during a financial year.
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Hence if X Ltd. earns a profit of Rs 40 crore and decides to distribute a dividend of Rs 2 to each shareholder & if you are a holder of 200 shares of X Ltd., then you would receive Rs 400 as a dividend. This is the benefits of investing in shares of X Ltd.
Declaration of dividend is not compulsory. But many good companies maintain a good dividend track record.
Capital Appreciation
You also benefit from capital appreciation. Simply put, this means an increase in the value of the company usually reflected in its share price.
Companies generally do not distribute all their profits as dividends. As companies grow, profits are reinvested in the business.
This means an increase in net worth (capital of the company plus accumulated profits that have not been distributed), which results in appreciation in the value of shares.
Hence, if you purchase 200 shares of X Ltd. at Rs 20 per share and hold the same for two years, after which the value of each share is Rs 35. This means that your investment has appreciated by Rs 3,000/-.
Non-Monetary Benefits of Investing in Shares
Apart from dividends and capital appreciation, the benefits of investing in shares are also non-monetary in nature. Bonus and rights issues are two such noticeable benefits.
Bonus Shares
Instead of distributing accumulated profits as dividends, companies have the option of issuing bonus shares, i.e., they will give more shares to you free of cost.
Prima facie, it does not affect your wealth as a shareholder, however, in practice bonuses carry certain latent advantages such as tax benefits, better future growth potential, an increase in the floating stock of the company, etc.
Hence if X Ltd. decides to issue bonus shares in a ratio of 1:1, and you are currently holding 200 shares, you will receive an equivalent number of shares (200) free of cost. Normally the price of X Ltd. will then fall in the stock market to keep your overall wealth at the same level.
This reduced price is called the ex-bonus price.
For example, if the price of X Ltd. in the stock market was Rs 40 before declaring this bonus issue, it would fall to Rs 20 after the issue.
Hence, your investment value which was Rs 8000 (200 shares x Rs 40 per share) would remain the same (400 shares x Rs 20 per share). In case the bonus ratio was 1:2, i.e., for every 2 shares held the company issues 1 bonus share, you would have received 100 (200/2 = 100) bonus shares.
Rights Issue
A company may need more money to expand and for that, it may need to issue more equity shares. A rights issue involves issuing additional shares to the existing shareholders of the company. A company wishing to issue additional shares should first offer them to its existing shareholders so that it allows the existing shareholders to maintain the same degree of control of the company.
Suppose the company declares a right issue in the ratio of 1:5, then for every 5 shares you hold you receive an additional one share.
The price of this additional share is generally less than the prevailing price.
Thus you can increase your participation in the company future profits.
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Hope this clarifies what one receives when he/she invest and buys shares. Do let me know your views & queries in the comments section below.
