What are equities can mean any number of things, as ‘equity’ has a different meaning dependent on which field it is applied to. The purpose of this article is to explore equities in the publicly listed sense. Although many of you will be familiar with the share price of your favourite equity, do you know the unsexy part?
What are equities
Why equities are useful
Risks to investing in equities
Equities or stock give the owner the ownership of an asset. In the case of listed equities, most owners, known as shareholders, will commonly own a small percentage of the overall equity in a listed company as part of a stock portfolio. Any shareholder who owns more than 3% is required to notify the issuer about their holding.
This allows other shareholders to know who theoretically has influence over the company. Most companies will have a a few major shareholders who management are always keen to keep onside. These larger shareholders, often portfolio managers and hedge fund managers, will have advantages such as being consulted in advance for changes in strategy.
Fortunes can be made and lost!
Equities are risky due to their lowly ranking in case of an insolvency. They rank below other creditors such as bond holders, and even preference shareholders. An investor should be aware of the equity risk they are taking. As a result they should seek an equity risk premium when investing in them.
We live in an interconnected world where technology companies have the fastest growth. Investing in these megatrends is therefore a good idea, but few of us can buy one these companies outright. Equities give you a chance to buy a share in these companies and enjoy the growth and hopefully, share price appreciation.
As a shareholder you have rights, such as voting at the annual general meeting on such things a director’s pay. Owning a share also gives you the ability to engage with the company, by asking their investor relations team any questions you may have. The more you know the company you are investing in by performing fundamental analysis, the better decisions you can take.
Equities can go bankrupt, as you are at the bottom of the insolvency table you can lose everything. Although cases such as Carillion and NMC health are fairly rare, creative accounting does happen to FTSE 100 companies. Size does always mean safety.
Tesla stock has proven to be both one of the most volatile stocks. Hot stocks can growth your capital very quickly. This is where have a margin of safety, portfolio protection and diversification are important.
Sometimes the regulator works against you
There are also regulatory rule changes to consider. Recently some have not been beneficial to shareholders. Firms can now place up to 20% of their value in shares without recourse to shareholders. This is something companies such as WH Smith have been quick to take advantage of. This increases the dilution of existing shareholders to their detriment.
How to start investing requires a lot of patience and hard work! Over a period of 5 years (i.e. an economic cycle) it is possible to grow your wealth using equities. You will be required to be patient, as it takes time for growth to come through. You will have to learn from your mistakes.
Learning what markets think is important, but learning about balance sheets and cashflow statements is critical. Understanding how companies manipulate these (red flag! Stay away!) will only come with experience gained through hard work.
Although accounting may appear at first glance complicated, as a beginner there are still some basic checks you can do. If the company has interest on debts of $50m a year and is producing $100m of cashflow a year, is this company truly profitable enough to invest in? Probably not when you consider it has to pay it’s staff and taxes too.
Furthermore, what are its outright debts like? On the balance sheet you will the current and long-term liabilities. Current liabilities are due within a year, whereas long-term are more than a year. If you can see that it has $800m of debt due in 3 years (long-term liabilities) and only produces $100m of cash a year, then a cash crunch is coming! Benjamin Graham has written about this and his work and teachings are well worth further investigation.
This subject area is so vast this article could of been as long as a book. In focusing on certain aspects, such as shareholder rights and regulatory rule changes, we hope to have highlighted areas you may not have focused on before. They are important though.
When choosing an investment you will have to take a holistic approach and perform an all-encompassing research, which will involve knowing everything about everything! This should involve trying out the key product that publicly listed company is making. You will never stop learning and making mistakes when investing. It is part of the deal you signed up to when entering this world!