Equities

Overview

Equities, also known as stocks and shares, represent an ownership stake in a company, allowing large investors to own large stakes and small investors to own tiny stakes. 

Owning a share entitles the holder to a proportional claim on the company's profits and assets, which can come from two sources. The first source is capital gains, which occur when the share price rises, allowing the shareholder to be able to sell the stake for more than they purchased it for. The second is in the form of dividends when the company distributes the proportional share of its profits directly to its shareholders.

Share types

The first type of shares is ordinary shares, which are the standard form of equity, and carry voting rights on important company decisions such as deciding board members. They also guarantee a residual claim on profits after all other obligations are met.

Preference shares are the next type of share, which sit somewhere between ordinary shares and debt, and usually pay a fixed dividend, but these dividends are paid before ordinary shareholders. Furthermore, if the company goes down, preference shareholders are paid out before ordinary shareholders. However, the growth potential on these shares is low, and they carry no voting rights.

How companies issue equity

To start issuing equity, a company first sells shares to the public during an Initial Public Offering (IPO), which is typically arranged and underwritten by an investment bank or financial institution, and once listed, a company can then raise further capital through a secondary issue. In addition, they can also offer new shares to existing shareholders via a rights issue (usually at a discount to encourage potential take-up).

Valuation

There are two most commonly cited metrics for equities, which are the price-to-earnings (P/E) ratio and market capitalisation.

P/E ratios refer to a company's share price divided by its earnings per share, and dividend yield, thus expressing the annual dividend as a percentage of the share price. Typically, companies in industries that are seen to have high potential growth, such as technology and AI, will have high P/E ratios due to speculation that the company will be earning lots more profit in the future, thus pushing up the price of the stock in the present.

Market capitalisation is the share price multiplied by how many shares are in issue, which gives a simple measure of a company's total equity value.

Risks

Equity returns are inherently volatile as share prices move largely with company news and industry sentiment, making investors buy and sell all of the time, resulting in vast changes in price. 

Also, existing shareholders can be diluted when a company issues new shares, which is a problem if a company goes down, as equity holders are last to be paid behind secured and unsecured creditors.