Equity
What is equity? You hear this word everyday, when you watch business news channels, when you travel in local train or in any other situation, but what is it exactly?
Equity is defined as stock or any other security representing an ownership interest in a company listed on the stock exchange.
An equity share is a right to a share in the profits of a Company. If you want a share in the company's profits, you can do so by buying an equity share.
Basic information on equity investing
Equity investment refers to buying a piece of a company. You do this by buying shares in that company. There are two ways to acquire shares in a company: from the primary market, where you buy a company's share when it first issues shares (or equity). This first share offering is called an initial public offering (IPO). Or, you could buy equity in the secondary market, which is the stock exchange.
When you buy or sell equity on a stock exchange, you have to do the transaction through an exchange-certified broker/brokerage firm, who will now act as your agent whenever you want to buy or sell equity.
Equity investments are high-risk high-return propositions. There is scope for serious erosion of capital as well as considerable appreciation. This depends on many factors such as performance of the company, general market conditions, state of the economy and so on...
In an investment portfolio, the equity portion represents one end of the risk-return spectrum, the high end. No other investment tool gives you this much scope for capital appreciation.
Risks inherent in equity investing
The risk factor in equity investments is appreciably higher than fixed income securities such as fixed deposits or National Saving Certificates, or post office monthly income schemes.
Like any avenue of investment (except those whose returns are guaranteed by the government, like the PPF), equity investing comes with risk. In fact, the risk factor in equity investments is appreciably higher than fixed income securities such as fixed deposits or National Saving Certificates (NSC), or post office monthly income schemes.
Company stocks are susceptible to risks, and these risks are carried forward to your investments as well. Here are a few:
-Business risks: The risks associated with the prosperity of a business and the demand for its products. There is always a risk that buyer profile or habits might change suddenly and a company's product goes from being the rage to an also-ran.
-Financial risks: The skill with which a company's finances are managed to ensure that it has an optimum level of debt, equity, reserves, etc. If a company's financials are ineptly handled, even in the short term, chances are that the ineptness will show up as a run on the stock in the future.
-Industry risk: Changes in technology, regulations, vogue, etc. can affect the performance of an industry sector as a whole, and a company stock of that sector might take the fall along with all its other competitors in that sector.
-Management risks: The level of corporate governance, management skills and vision determines the long term health of a company. Short term, ad hoc management decisions to ramp up profit sheets invariably leads to long-term grief for that company.
-Exchange rate risks: These factors affect a company but are outside its control, such as a sudden strengthening of the rupee that might affect exports, having adverse effect on an export-oriented company's stock.