Equity Securities Overview

Equity securities are shares of stock that represent a proportional share of ownership in a company's net assets and profits. However, being a shareholder of a company does not give you the right to run the business as per your wishes. As an owner, you are entitled to your share of the company's profits and have an entitlement on their assets as well as any voting rights attributed to the stock.  The distinctive characteristic of an equity security is the limited liability attached to it. If the company is unable to pay its debts, you may end up losing the maximum value of your investment.  Only a certain type of company called a corporation has stock; other types of companies such as sole proprietorships and limited partnerships do not issue stock.

Why does a company need to issue stock? The reason is that every company needs to raise money. To do this, companies can either take a loan of it from somebody or raise it by selling part of the company, which is known as issuing stock. A company can borrow by taking a loan from a bank or by issuing bonds, known as debt financing. Here, the lender does not gain an ownership interest in your business and your obligations are restricted to repaying the loan. Alternatively, issuing stock is called equity financing. Issuing stock is beneficial for the company because it does not require the company to pay back the money or make interest payments along the way. All that the shareholders get in return for their money is the expectation of an appreciation in the price of the shares making them worth more than what they paid for them. However, the main drawback to equity financing is the diffusion of your ownership interests and the possible loss of control that may be an adjunct to sharing of ownership with additional investors.

Equity securities normally pay off dividends to the buyer, but do oscillate in their market value depending on the ups and downs of the market and the economic condition. The performance of the business is also the key factor, which will drive the value of the stock either higher or lower, the better the performance the higher the value of the equity security.

Types of Equity Securities

Common Stock

Common stock holders usually have the right to vote on major company decisions and are entitled to receive a share of the company’s net assets when dividends or other distributions are handed out. Investors get one vote per share to elect the board members, who supervise the major decisions made by management.

Preferred Stock

Preferred stock holders do not usually have voting rights, but receive a specific dividend before any dividends can be issued to other common shareholders. The main benefit to owning preferred stock is that the investor has a greater claim on the company's assets than common stockholders. In case, the company goes bankrupt, preferred shareholders are paid off before common stockholders. 

There are different types of preferred stock:

Cumulative Preferred Stock

A form of preferred stock on which unpaid dividends accumulate in the event that the issuer of the stock does not make timely dividend payments.

Non-Cumulative Preferred Stock

In contrast to cumulative preferred stock, the unpaid dividends do not accumulate gradually.

Convertible Preferred Stock

Another form of preferred stock which provides an option to the holder to convert the preferred shares into a fixed number of common shares, which is generally anytime after a pre-specified date.

Redeemable Preferred Stock

This preferred stock comes with an agreement that the company can buy them back at a fixed date in the future.

Common and preferred are the two most important forms of stock; however, it is also possible for companies to modify different classes of stock in any way they want.

Trading Equity Securities

Equity securities may be traded either on an exchange or in the over-the-counter market. A stock exchange provides a marketplace for either physical or virtual trading of shares, bonds and warrants and other financial products where investors buy and sell shares of a wide range of companies. The NYSE is the first type of exchange, where much of the trading is done face-to-face on a trading floor. NASDAQ is a virtual stock exchange, where the trading is done over the counter. For trading, you need a broker to handle your trades – usually individuals don’t have access to the electronic markets. Your broker can have direct access the exchange network wherein the system finds a buyer or seller depending on your order.

It is important to understand that there are no income guarantees when it comes to individual stocks. Any stock may go bankrupt, in which case your investment is worth zero. Investing wisely in stocks can reap long term capital growth and steady dividends. To determine whether a stock is over- or undervalued, investors compare its price to revenue, earnings, cash flow, and other fundamental criteria.  Please bear in mind that investment in stocks is risky and therefore, it is advisable to consult a qualified financial advisor and make informed decisions as per your financial goals and risk profile.