What Does Equity Mean and What is an Equity Investment?
What is an Equity Investment? There are two main categories of investments (securities) in the financial world, Equity and Debt investments. Our focus will be on equity securities, but first let’s define equity. Equity in this case means ownership of something. When you build equity in your house by paying your mortgage each month you are building your equity in it (ownership of it).
What is an equity security? An equity security provides an opportunity to participate in the companies prosperity. This can be in either capital appreciation, sharing in company earnings, or both! The most well known equity securities are stocks. There are two types of stocks: Common Stock and Preferred Stock. We will discover the benefits and risks to both of these types of equity investments below.
What is an Equity Investment?
The most popular equity investments are Stocks. This includes both Common and Preferred Stocks. Equity means ownership of something. When you build equity in your house by paying your mortgage each month you are building your equity in it (ownership of it). When you purchase a Common Stock you are becoming part owner of the company.
What is an Equity Investment: Common Stock
What is Common Stock
Common Stock is what many refer to when they say stocks or the stock market. Common stocks are the most popular answer to what is an equity investment. With Common stocks, a company will issue common stock to raise money. An investor will buy these shares and as a result are part owners of the company. The investor/owner of each share of stock is entitled to a portion of the companies earnings and dividends and a proportionate vote in major decisions.
Most companies are organized so that a Board of Directors represents the stockholders in all of it’s day to day operations. The Board of Directors is elected from the stockholders on a regular basis. This way the stockholders have a say in the company management. This is why is important to know not just the technical analysis but the fundamentals and ethics of a company before you purchase their stock. In purchasing a stock you are becoming part of that company and you should believe in it and that they will grow. Otherwise find another stock, there are plenty available! Let’s go over the benefits and risks of common stock.
What is an Equity Investment: Benefits and Risks of Owning Common Stock
The key takeaways from common stocks are the following. You would want to invest in common stocks for Capital Appreciation, as a Hedge Against Inflation, and for Income from Dividends. However, when you invest with common stocks you are accepting Market Risk and Business Risk. For instance, if the company performs poorly they may not pay dividends and could file for bankruptcy where you can lose the principal you invested. Now it’s time to learn about Preferred Stock.
What is an Equity Investment: Preferred Stock
Preferred stock in an equity security because it represents a type of ownership in the issuing company. However, preferred stockholders have no voting rights, a key difference from common stockholders. Although it is classified as an equity security it behaves very similarly to a debt security. Unlike a common stock, the rate of return of a Preferred Stock is fixed. A preferred stock’s annual dividend represents its fixed rate of return. Similarly, debt securities have a fixed rate of return.
The fixed rate of return is a key attraction to income investors. Typically the preferred stock is identified by its annual dividend as a percentage of its par value. Additionally, the par value is always assumed to be $100. The price of preferred stock fluctuates from interest rates and the companies ability to pay dividends, similar to debt securities. Additionally, there are a number of different types of preferred stocks tailored to different investors. Let’s take a look at the benefits and risks of preferred stock.
What is an Equity Investment: Benefits and Risks of Owning Preferred Stock
In summary, the main reasons someone would invest in preferred stock are for Fixed Income and Higher Payment Priority over common stock. However, the risks with preferred stock are Loss of Purchasing Power, Interest Rate Risk, and Business Difficulty. Similar to common stock, if the companies business is suffering they may not be able to pay any dividends.
What is an Equity Investment: Knowledge is Power
We hope we provided an acceptable answer to “what is an equity investment?” Above all, YP Investors aims to educate and help to grow your wealth. Make sure to look at the benefits and risks of both common stock and preferred and select which suits your goals better. Additionally, be sure you are investing in sound fundamental and technical stocks whether they are common or preferred. We have the stock analysis tools and market condition alerts for our members. Try them out risk-free with a 3-Week Free Trial membership. Use your knowledge to grow your wealth, good luck on your investments!