What is ‘equity’?
‘Equity’ is an entity’s value minus all its financial liabilities. An entity may be anything from a single business, a company operating a range of services and sectors, or an asset.
In business, a company’s net worth—after expenses and debts are paid off—is its equity. Equity can also refer to investments in which investors purchase part-ownership of the business in exchange. This capital is equivalent to the monetary value of the shares that the investor purchases.
Some common equity investments are individual shares, managed funds—such as indexed funds and exchange-traded funds (ETFs)—and real estate trusts.
What is a share?
Shares are a type of equity investments. Shares give investors part-ownership of the issuing entity’s business in exchange for additional capital.
The company may issue different types of shares to raise capital for its business. These shares are listed in markets like the Australian Securities Exchange (ASX) where investors could trade, buy and sell these shares.
Shares may come with voting rights on important company matters, as well as rights to company profits through dividend payments.
What are equity shares?
Equity shares refer to ordinary or common shares issued by the company for public trading.
These equity or common shares come with voting right and dividends, but dividend payouts are not always guaranteed and voting rights usually depend on the class of common shares purchased.
The total number of shares a company is allowed to issue would depend on its stock, but each share gives the shareholder equal ownership and entitlement.
What makes shares different from stocks?
A stock refers to part-ownership of the issuing company which comes with voting rights and dividends.
That sounds exactly like shares but there’s a difference: a stock refers to the entire number of shares and shares represent portions of the company’s stock which the public has access to.
Imagine a giant pie as the company’s equity and the excess crust that was removed prior to baking as its liabilities. If the whole pie represents the company’s stock, then each slice is a share unit—whether preference or ordinary—that investors could purchase.
Types of equity shares
Apart from the different classes of common stock that exists, there are also different types of equity shares that companies can issue. The types depend on the reason for issuing shares and to whom they are issued for, as discussed below.
Sweat equity shares: Issued to individuals who have “shed an exceptional amount of sweat for the company”. These are given to company employees and officials who were able to provide exceptional service and valuable contributions that helped the business grow.
Bonus shares: Issued to existing shareholders as a dividend or in place of it.
Bonus shares are given by the issuing company for free if they decide to capitalise profits from previous years which were held in their reserves.
Rights shares: The number of shares a company can issue is usually already determined before its initial public offering (IPO), but companies may sometimes be granted permission to issue new shares. To protect the rights of its current shareholders, companies issue rights shares.
Rights shares are like early access pass for existing shareholders to purchase the new share issues at a discounted price for a limited time.
On the downside, a shareholder who exercises the option to purchase rights shares may find that the price per share decreases even as the portfolio’s value increases. However, this would still depend on the market’s reaction to the issuance of rights shares.
Earning from shares
Shareholders can earn from shares in two ways: dividends and value appreciation.
Dividends: Shareholders have rights to dividends from the company’s profits for the financial year, but investors should remember that companies are not actually required to pay out dividends to its shareholders.
Value appreciation: The company’s value increases as it expands and grows. Investors who own shares that have appreciated in value will accumulate unrealised gains because of the increase in value, and shareholders may capitalise on it by selling their shares at a premium.
It is best to consider both when shopping for shares to purchase and to select their investments carefully.
This information has been sourced from the Australian Taxation Office and ASIC’s Moneysmart.