By Dela Agbo
In the previous article titled “Equity vs. Debt: Understanding Two Key Investment Assets,” we explored the fundamental differences between debt and equity.
While debt instruments like bonds provide fixed returns and capital preservation, equity offers a dynamic path to wealth creation—albeit with higher risk.
This follow-up article takes a deep dive into equity investing, exploring what equity is, its types, features, and how it impacts your portfolio. We’ll also discuss how investors make money through equity and the corporate actions that influence equity value.
What is Equity?
Equity represents ownership in a company. When you buy shares of a publicly listed or private company, you essentially acquire a portion of that business. This ownership entitles you to a share of the company’s profits and assets—depending on how much you own.
In the context of corporate finance, equity appears on the company’s balance sheet as shareholders’ equity, which includes:
- Paid-in capital (from issuing shares),
- Retained earnings (reinvested profits), and
- Other reserves.
Types of Equity
Equity can come in various forms, depending on the investment vehicle and stage of the business:
- Common Equity (Common Shares):
- Most common type for public investors.
- Carries voting rights and allows investors to benefit from capital gains and dividends.
- Last to receive assets in the event of liquidation.
- Preferred Equity (Preferred Shares):
- Hybrid between debt and equity.
- Pays a fixed dividend and has priority over common shares in dividends and liquidation.
- Often does not come with voting rights.
- Private Equity:
- Equity investments in private companies (not listed on public stock exchanges).
- Typically involves venture capital, growth equity, or buyouts.
- Illiquid but has high return potential.
- Founders’ Equity:
- Equity held by original founders of a company.
- May come with special voting rights or restrictions on transferability.
- Employee Stock Options and ESOPs:
- Equity compensation provided to employees.
- Aligns employee interests with company performance.
Features of Equities
- Ownership: Equity represents ownership in a company and the right to a proportional share of profits.
- Voting Rights: Common shareholders often have the right to vote on major corporate decisions.
- Dividends: Some companies distribute a portion of earnings to shareholders as dividends.
- Volatility: Prices of equities fluctuate based on company performance, market sentiment, and macroeconomic factors.
- Residual Claim: In case of liquidation, equity holders are paid after debt holders.
Corporate Actions that Affect Equities
Corporate actions are events initiated by a company that directly affect its securities and stakeholders. Common examples include:
- Dividends: Cash or stock payments to shareholders. Signals financial strength but reduces retained earnings.
- Stock Splits: Increases number of shares while reducing price per share. Enhances liquidity.
- Reverse Stock Splits: Reduces number of shares, increasing price per share. Often done to maintain listing requirements.
- Rights Issues: Offers existing shareholders the right to buy more shares, often at a discount.
- Buybacks (Share Repurchase): Company buys its own shares from the market, reducing supply and potentially boosting share price.
- Mergers & Acquisitions: Affects share prices based on perceived value creation or dilution.
- Bonus Issues: Additional free shares issued to shareholders, often from retained earnings.
How Equities Impact Your Investment Portfolio
Investing in equities can significantly influence your portfolio in the following ways:
- Capital Appreciation: Equities tend to outperform other asset classes like bonds over the long term.
- Income Generation: Through dividends, investors can enjoy regular income.
- Diversification: Different sectors and markets offer various risk-return profiles.
- Liquidity: Publicly traded shares can be bought and sold easily on the stock exchange.
- Inflation Hedge: Equity investments generally provide better protection against inflation than fixed-income assets.
However, equities also introduce volatility and market risk, meaning they are best suited for long-term investors with a higher risk appetite.
How to Make Money Investing in Equities
There are two primary ways investors earn returns from equity investments:
- Capital Gains:
- When the price of a stock rises and you sell it at a profit.
- Influenced by earnings growth, economic conditions, investor sentiment, etc.
- Dividends:
- Companies may share profits with shareholders regularly.
- Dividend-paying stocks provide a source of passive income.
Bonus Tip: Reinvesting dividends (known as Dividend Reinvestment Plans or DRIPs) can enhance compounding and long-term wealth.
Conclusion: Why Equity Should Be Part of Your Investment Strategy
Equities offer investors ownership, growth potential, and income, making them a foundational component of any long-term investment portfolio. Though more volatile than debt instruments, equities have historically provided superior returns over time.
Understanding how equity works—and how corporate actions, market sentiment, and economic cycles affect your investments—empowers you to make informed decisions. Whether you’re an individual investor or a corporate fund manager, a balanced allocation to equity is essential for building long-term wealth.
Coming Up Next:
In our next article, we will explore how to build a balanced investment portfolio using a mix of equity, debt, and alternative assets to match your risk appetite and financial goals.
