Equities, commonly known as stocks, are ownership shares in a corporation. This asset class is a cornerstone of most investment portfolios, offering potential for growth through capital appreciation and dividends. However, success in the stock market requires a comprehensive understanding of its fundamentals, risks and opportunities. This article aims to equip investors with the essential knowledge needed to understand equities, from their basic characteristics to the strategies for investing in them.
THE BASICS OF EQUITIES
At its core, purchasing equity in a company means buying a piece of that company. Shareholders, therefore, have a claim on the company's assets and earnings. The size of this claim depends on the number of shares owned relative to the total outstanding shares. Equities are issued by companies to raise capital and investors buy them with the expectation of receiving dividends and seeing appreciation in the share price.
TYPES OF STOCKS
Stocks are broadly categorised into common and preferred shares. Common shares grant voting rights, allowing shareholders to vote on company matters, including board elections. However, they come with no guaranteed dividend and rank lower than preferred shares in the event of liquidation. Preferred shares typically do not offer voting rights but provide a fixed dividend and priority over common shares for asset distribution if the company is dissolved.
Equities are further classified based on company size (market capitalisation), sector and geography. For instance, stocks can be from large-cap (large companies), mid-cap (medium-sized companies) or small-cap (small companies) entities. They can belong to various sectors, such as technology, finance or healthcare and can be domestic or international, offering investors a wide range of investment opportunities.
VALUING STOCKS
Understanding how to value stocks is crucial for investors. Stock valuation involves determining the intrinsic value of a company’s share based on earnings, growth prospects and the overall financial health of the company. Common valuation metrics include the price-to-earnings (P/E) ratio, price-to-book (P/B) ratio, dividend yield and earnings growth rate. While no single metric can provide a complete picture, together they offer valuable insights into a stock's potential worth and investment appeal.
THE ROLE OF DIVIDENDS
Dividends are payments made by a corporation to its shareholders, typically derived from profits. Not all companies pay dividends, with growth-oriented firms often reinvesting profits into the business to fuel further growth. For income-focused investors, dividends are a key attraction of stock ownership, providing a regular income stream and signalling the company's financial health and stability.
EQUITY MARKETS
Stocks are traded on equity markets, such as the London Stock Exchange (LSE) and New York Stock Exchange (NYSE). These markets facilitate the buying and selling of stocks, providing liquidity and price discovery through supply and demand dynamics. Stock prices fluctuate constantly during trading hours, influenced by company news, economic indicators, market sentiment and global events.
RISKS AND RETURNS
Investing in equities involves risk, including the possibility of losing the entire investment. Stocks are subject to market risk, company-specific risk and industry risk, among others. However, they also offer the potential for high returns, outperforming other asset classes over the long term. The key to managing equity risk is diversification, spreading investments across various stocks, sectors and geographies to mitigate the impact of any single investment's poor performance.
INVESTMENT STRATEGIES
Investors approach equities with different strategies, including growth investing, value investing and dividend investing. Growth investors seek companies with strong potential for revenue and earnings growth, while value investors look for undervalued stocks that trade below their intrinsic value. Dividend investors focus on companies that pay high dividends. Each strategy has its merits and risks and investors may choose one or a combination based on their investment objectives and risk tolerance.
Equities offer a dynamic and potentially rewarding investment opportunity, but they require a solid understanding of their fundamentals, valuation techniques and market behaviour. By comprehensively understanding the types of stocks, how to value them, the importance of dividends and the dynamics of equity markets, investors can make informed decisions tailored to their financial goals. Diversification and a clear investment strategy are key to navigating the risks and opportunities in the equity markets, aiming for long-term growth and financial success.
This Trustnet Learn article was written with assistance from artificial intelligence (AI). For more information, please visit our AI Statement.