What is a stock or equity ?

What is equity or stock of a company signify? What is equity investment ? If these are questions that have clogged your mind especially since you must have heard about the phenomenal returns from equity, read on.

Equity or stock ?

Equity is defined by the valuation of a property minus any debts there are on that property. Let us see how this relates to the stock market. Whenever someone wants to start a business, they need money.

The money can be collected by two means – one is where the business promoters put in their own money and another one is where they ask investors like you and me to contribute money. The promoters would do the latter because they don’t have all the money to start the business.

If you decide to contribute, you get in return an ownership of the company. This unit of ownership in the company is called an equity share. Over a period of time, the word share has come to refer to stocks as well and subsequently they have been used interchangeably.

For example, if a company issues out 30,000 shares to the public and you hold 300 shares, you own 1% in the company (300*100/30000).

Equity investment is your loan to the company that can either be paid back or not. This equity investment entitles you to the profits and losses that the company generates. So when you invest in equity in a company, there is no guarantee that you are going to get your money back.

What does ownership mean ?

Well obviously, if you own 1% or more/less in a company, you cannot romp into their office naked and say Hi. There are some guidelines which come into play. Your minor ownership does not entitle you to daily operations working of the company. Your clout will depend on what kind of equity you have bought.

As far as equity shares are concerned, they have no preference as far as pay out of dividends is concerned – that is, there is no guarantee that investors who hold equity shares will get dividends year after year. In contrast, the preference shareholders are paid the dividend and capital first than equity shareholders. In fact, the rate of dividend is usually fixed for preference shareholders. Equity shareholders have normal voting rights.

Since you have bought an interest in the company, you take the risk of losing your investment in case the company goes out of business. In such a case, all you lose if your investment (the small 1% in our earlier example).

Why would you buy equity ?

When you buy ownership in a company, you stand to benefit from a host of factors.

Firstly, if the business you invest in does well, you reap benefits either in the form of dividends or in form of capital appreciation of your investment.

Dividends are nothing but your earnings on the capital you invested and they can be either Interim or Final. Final dividends are declared at the end of the financial year while interim dividends are declared during the financial year.

Capital appreciation is increase in value of your equity money that was invested. Capital appreciation is reflected in increase in value of the stock price of the company.

Secondly, there is no income tax either on the dividends you receive or on the long term capital gains you earn from the capital appreciation. So you save tax !.

Thirdly, shares are very liquid investments – you can sell them out pretty quickly and generate cash. Obviously, this is applicable only for those firms which are big and promising – small firms could turn illiquid very quickly.

Given the fact that the returns from equity have been more than any other asset class over a long period of time, I am sure you would eye an ownership of some quality companies now.

So what then is Home Equity ?

In my opening para, I defined Equity  by the valuation of a property minus any debts there are on that property. The same applies for your home as well.

A house is generally purchased through a loan. The total current market value of your house minus any outstanding loans is your home equity. Similar to the ownership of stock equity, the home equity defines the owners total ownership in his house – this ownership increases as the loans are paid over a period of time.

So, in a way, equity ownership definition is applicable in the same way to your home as it is to a firm whose stock you buy.