Equity investments refer to money invested in a company by purchasing stocks and shares (including preferred stock). These financial securities represent a small part of an underlying business. And the owner subsequently has a claim on the profits generated.
While most shares are traded between investors, companies often issue new shares to the investing public as a method of raising capital. This is also known as equity financing and is commonly used by unprofitable companies that lack sufficient cash flow to afford to go into debt.
Equity investments are not just limited to the stock market. Even private companies have shares that can be bought. However, the barriers to investing in a private company are significantly higher than in a public one. That’s why typically only venture capital and private equity firms explore this region of financial markets.
What are the benefits of equity investments?
Investing in stocks can bring multiple benefits.
- claim for benefits – Owning shares means owning a claim on earnings. Therefore, when the company makes money, so do the shareholders. And this is reflected in an increase in the price of shares or through dividends. The latter can even be used to establish a passive income stream that can potentially lead to a more comfortable or earlier retirement.
- Capital Profits – As mentioned above, higher earnings mean a higher stock price. As such, any capital invested today could be worth much more in the long run. In extreme cases, it is possible to generate huge profits with stock prices rising by five-fold digits.
- Right to vote – As part owners, shareholders have the right to vote on important decisions at the annual general meeting (AGM) as well as other events. Each common share has the same level of voting power (exceptions exist for companies with multi-class share structures). Therefore, the more shares an investor owns, the more influence they will have during voting.
- High Liquidity – Unless you invest in penny and small-cap stocks, most publicly traded stocks have high levels of liquidity. As such, it is possible to execute buy and sell orders instantly, injecting and withdrawing money without delay.
Disadvantages of Equity Investments
While investing in stocks and shares can lead to substantial wealth generation, it also carries significant risks.
- capital depreciation – Trading profits don’t always go up. Even the world’s largest companies can be affected by external forces, whether it’s supply chain disruptions or macroeconomic policies. Companies that miss revenue and profit targets can see their share price drop rapidly. And investors may end up destroying wealth instead of creating it.
- Volatility – Stock prices can be exceptionally volatile, especially for smaller companies. In the short term, the stock market is driven by mood and momentum. And even the strongest companies with strong fundamentals and growing earnings can see their valuations fall in the short term.
- lowest priority – Should the worst case scenario occur and a company declare bankruptcy, equity investors are often left with nothing. This is because suppliers, creditors, and lenders take precedence over shareholders when it comes to meeting outstanding financial obligations. During the bankruptcy process, companies use their remaining financial resources and liquidate assets to obtain as much capital as possible to satisfy their debts. And by the time everyone else has been paid, shareholders often see their investments collapse.
What is the difference between equity and debt investments?
Equity is not the only source of capital for companies. Many times, companies exercise the debt option. And just like stocks, it is also possible to invest in debt.
There are several types of debt securities to choose from. But the most common are bonuses. Companies can issue bonds for public investors to purchase with a promise to pay interest until the bond matures. When a bond matures, the company returns the principal amount.
Debt investors earn their return through interest payments. And it’s not uncommon for covered bonds to be issued. This is a type of debt that is secured. Therefore, investors would still be protected even if a company is unable to repay the loan. That is why debt investments are considered significantly safer than equity investments. Also, during a bankruptcy, bondholders have priority over shareholders when it comes to getting their money back.
Unlike shareholders, however, this increased security has historically resulted in significantly lower returns. Debt holders also do not have the right to vote on corporate decisions. And furthermore, even if earnings increase, the interest rate on a bond will remain at the rate agreed upon when the bonds were first issued.
What is a variable income fund?
An equity fund, also called a stock fund, is a type of mutual fund that invests primarily in publicly traded stocks, private equity, or both. They are led by investment professionals with the experience to analyze and discover lucrative opportunities within the stock market.
Investors may choose to buy shares in a mutual fund instead of choosing individual shares. While there are annual management fees, this means that all investment decisions are handled by a professional. This makes it a popular investment method among beginners who want to put their portfolios on autopilot.
The bottom line
Equity investments can generate substantial returns for astute investors. However, it can be risky business. And people who have not established a viable investment strategy or done the necessary due diligence can very easily lose money.
Before making any investment decision, adequate research should be done to make informed decisions about the potential rewards and associated risks. For investors without the time or interest to carefully study opportunities within the market, it may be wise to speak with an investment advisor.
The 3 main actions to try to beat rising inflation
The stock market is reeling from the rising level of inflation. And with so many fantastic deals trading at deep discounts, now could be the perfect time for savvy investors to snag some potential bargains.
Deciding which stocks to add to a shopping list at times like these can be daunting for new and seasoned investors.
That’s why our top analysts at The Money Cog’s flagship Premium research service have just revealed what they think could be the three best buys for investors right now.
Also, we share all three in one FREE special investment report available today!
Request your free copy now
This article contains general educational information only. It does not take into account the personal financial situation of the reader. Tax treatment depends on individual circumstances that may change in the future, and this article does not constitute any form of tax advice. Before committing to any investment decision, an investor should consider his or her individual financial circumstances and contact an independent financial adviser if necessary.and.
Edited and verified by
Master of Science Zaven Boyrazian
Zaven has worked in various industries throughout his career, from aircraft factories to game development studios. He has been actively investing in the stock market for the better part of a decade, managing over $1 million across multiple portfolios.
Specializing in corporate valuation, Zaven employs a modern version of the principles established by Benjamin Graham to find new opportunities at fair prices.
