Equity investment enables investors to obtain a stake in companies by purchasing shares. Though the return on investment can vary significantly depending on company, sector and market, they remain a popular form of investment.
Understanding what equity investments are enables investors to evaluate the options, benefits and risks of becoming a shareholder. In this article, we explain what equity investment is, the main types of equity investment and equity investment funds.
What are equities investments?
Equities investments involves investors putting money into private or public companies by buying the company\’s shares and becoming partial owners of the company according to the proportion of shares they own. You can purchase these company shares when the company trades them as stocks on the stock exchange. By purchasing traded stocks, an investor becomes a shareholder with entitlement to a portion of the assets and profits of the company.
Understanding equity
Equity, also known as shareholders\’ equity, is a term used in finance that refers to the money or value that a company\’s shareholders keep in the event of complete liquidation of the company\’s assets after the satisfaction of all its debts.
Equity determines the valuation of a company as it represents the assets that the company holds minus any of its liabilities and is a key indicator of the financial health of a business. Here are some key points on equity:
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companies publish their equity on their balance sheet
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stock is the sum of the equity that a company accrues through selling shares to investors
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owner\’s equity or private equity is where investors hold the equity in a private company
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companies can use equity as a form of \’payment in kind\’
Why do investors make equity investments?
Investors purchase a company\’s shares, expecting them to accrue value over time and generate capital gains at the point of divestment or dividends. Equity investments are usually one of many types of investments that are made in a diverse investment portfolio. Equity investors receive money from shares that have increased in value when they sell them or if the company liquidates its assets and pays off its debts.
Why invest in equities?
Equity investment is a traditional form of investment that many people are familiar with. The equity stake of shareholders often yields returns that are greater than more conservative or safer investments. Here are some notable benefits of equity investment:
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Gains: The primary incentive of equity investment is the potential to increase the value of the original investment. Investors receive the gains on the principal amount as capital gains and dividends.
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Liquidity: Shares have high liquidity, meaning that investors can easily buy, sell or transfer ownership of them. They do not have the bureaucratic complexity of other asset classes, like property.
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Participation in decisions: Ownership of equity as shares confers partial ownership of the company. Shareholders can use their voting rights to steer the direction of the company.
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Limited liability: Equity investors have limited liability with an exposure that\’s proportionate to the size of their investment. Creditors cannot pursue these shareholders for losses that are above the value of their investment.
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Bonus share issues and stock splits: Companies may offer shareholders the opportunity to gain bonus shares or a stock split (that reduces the value of individual shares) that can increase the liquidity of their holding.
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Manage multiple investments: It\’s possible to invest in multiple companies simultaneously by using an equity fund. This means that investors can diversify their investments.
There are several types of equity investment
There are several equity investment options that have distinct rewards and risks. An equity fund may include some of these investments. Here are the main types of equity investment:
1. Common stocks
Common stock is a name given to ordinary or equity shares. Common stocks not only confer a share of company profits, but also the right to take part in votes on corporate policy and the composition of the executive board. These shares are not attributable to any particular assets and if the issuing company goes bankrupt, the shareholder is likely to receive nothing.
2. Preferred stocks
Preferred stock is a type of share that entitles the holder to a higher claim on dividends and other asset distribution compared to common stockholders. The specific financial arrangement in this investment varies by company but preferred stockholders usually have no voting rights. If there is a company liquidation, preferred stockholders have a greater claim on the remaining assets after the company settles its debts.
3. Stock warrants
Warrants provide the right to buy common stock at a specific time for a pre-arranged price called the exercise price. Companies issue stock warrants directly and investors cannot get them by buying them from other shareholders. They work similarly to stock options and typically expire if investors don\’t buy them.
4. Equity line of credit
Companies use equity lines to raise capital for use as needed, without the expense of debt. The investor makes a line of credit available to the company, which the company can access when needed. The repayment for use of the equity line is in discounted stock that is sold to the investor when the company chooses.
5. Convertible debt
Convertible debt is a type of equity-based bond that a holder can cash or convert into shares from the issuing company. It doesn\’t have collateral and usually gets priced lower than common stock. The companies that issue these bonds are usually fast-growing but have few lines of credit available to them and use the bonds as debt security.
6. Restricted stock
This is a special type of stock that carries specific restrictions on its transfer. Shareholders can only sell or transfer this type of stock once they meet conditions specified by the issuing company. For example, a company may award an employee restricted shares that prevent them from selling the shares immediately.
What are equity funds?
Equity funds are stock funds that enable investors to invest in a range of companies and grow their principle based on their performance as a group. Many investors consider equity funds a less risky alternative to direct investment in companies where you\’re wholly reliant on their performance. These funds use diversity to spread your risk across groups of companies selected by characteristics, including size, country or sector. The major categories of equity funds include:
1. Company size
Fund managers may group companies in an equity fund according to market capitalisation. This is the company size, as calculated by the number of available ordinary shares multiplied by the current share price. Fund managers can classify companies as either:
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Large-cap: These companies, also termed \’blue-chip\’ companies have a value that exceeds $10 billion. They usually deliver consistent growth and pay regular dividends.
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Mid-cap: These medium-sized companies typically have a value between $2 billion and $10 billion. Some investors consider these types of businesses to be a riskier investment than blue-chip companies, but many perform well and pay regular dividends.
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Small-cap: Smaller companies with a value of between $300 million and $2 billion carry higher risk and could become bankrupt. If they grow and become successful, their share price soars.
2. Industry
Industry equity funds organize groups of companies by sector. The companies may vary in size and the type of market they operate in. Common industries include:
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consumer
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retail
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dining
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technology
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energy
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mining
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finance
3. Developed markets
These are the financial markets of the developed economies of the world. Investors from any location in the world can choose to invest in companies from these wealthier nations that include the UK, US, Canada, Australia and Japan. Fund managers consider developed markets to be less risky, though they are not completely without risk.
4. Emerging markets
The emerging markets are popular for equity investment because of the promise of high-growth and significant gains. Developing economies are growing and by investing in companies based in these economies a stock portfolio has the potential to grow significantly. Equity funds from emerging markets target regions that include:
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the Middle East and North Africa (MENA)
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BRIC countries like Brazil, Russia, India and China
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Asia-Pacific countries, excluding Japan
Many investors consider that investing in emerging markets is risky, but this asset class is increasingly stable and offers excellent returns.
5. Buying equity funds
Investors who want to buy into an equity fund usually do this via a financial adviser or use online investment platforms. Purchasing shares in an equity fund usually carries a fee that is paid to the adviser or platform and tax liability depending on your region and financial circumstances. Investing in an equity fund online without financial advice is at your own risk.