Difference between Equity and Preference Shares

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Difference between equity and preference shares

Companies need capital to run their operations and finance their growth. They can raise capital either through debt, equity, or both. The capital structure of the business is the combination of debt and equity used to finance its operations and growth. Debt is money borrowed from another party, which needs to be returned. Typically, debt involves interest payments, at a pre-decided rate, by the borrowers to the lenders. 

Equity involves raising money by giving an ownership stake in the business. With equity, companies can raise money by issuing equity shares or preference shares. Equity shares do not involve any fixed payments to equity shareholders. Also, companies are not obligated to return the funds raised from equity shareholders. The return on their investment is linked to the performance of the company. If the company goes bankrupt, equity shareholders risk losing their entire investment. 

Preference shares have characteristics of both equity shares and debt. Let us understand the key differences between equity and preference shares.

Important differences between Equity and Preference Shares

Mandatory/Voluntary Status

Every company must issue equity shares. However, the issuance of preference shares is voluntary.

Dividend Payments

Companies distribute their profits to their shareholders through dividends. While both equity and preference shares may receive dividends, there is a key difference. Equity shares are not entitled to any dividends. Even if a company is making profits, it can choose not to pay any dividends to equity shares owners. Also, the rate and amount of equity dividends can fluctuate. On the other hand, preference shares offer a fixed dividend. Companies have to pay the dividends on preferred shares first before paying any dividends on equity shares.

Order in Claiming the Company’s Assets

Both equity and preference shareholders are owners of a company. If the company goes bankrupt, both stand to lose their capital. However, in such an event, preferred shareholders have an advantage. Companies must settle the claims of preference shareholders first before paying any money to equity shareholders.

Voting Rights

Equity shareholders have the right to vote on every resolution (key decisions of a company) related to the company. Examples of key decisions include mergers and acquisitions or the appointment of the board of directors. However, preference shareholders can vote only on matters relevant to preference shares. 

An example includes a decision related to liquidating the company. However, there is an exception to this rule. If a company has not paid any dividend to preferred shareholders for two or more years, they get voting rights for every resolution, similar to equity shareholders.

Variety of Types

Equity shares can either be ordinary equity shares or differential voting rights (DVR) shares. DVR shares are similar to ordinary shares, except they have fewer voting rights. Preference shares can be of many types, including:

  1. Convertible (can be converted into equity shares) vs non-convertible
  2. Cumulative (dividends get accumulated if not paid in any year) vs non-cumulative
  3. Participatory (provide additional dividends subject to the company meeting certain targets) vs non-participatory

Trading in Exchanges and Liquidity

Equity shares in India trade on exchanges such as the Bombay Stock Exchange or the National Stock Exchange. Any retail investor with a Demat account can purchase equity shares. This makes equity shares highly liquid. On the other hand, preference shares do not trade on exchanges. These shares trade in the Over the Counter (OTC) market, where shares trade informally. As a result, preference shares are relatively less liquid.

Redemption versus Share Repurchases

There is a specific type of preferred shares known as ‘Redeemable Preference Shares’. These shares are redeemed or repaid after a certain time period. Shareholders must sell the stock upon redemption.

In share buybacks, the company buys back its shares at the current market price. This is a popular way of returning cash to equity stockholders. However, share buybacks are entirely voluntary, and shareholders can choose not to sell their shares.

Rights to Shareholders

Equity shareholders have voting rights, and they also become owners of the business. While preference shares do not have voting rights, they have several other rights. Examples include right of the first offer, right of first refusal, tag along, drag along, etc.  Some of these rights may offer extra protection and benefits to preference shareholders.

Bonus Shares/Rights Issue

Companies may issue bonus shares to equity shareholders. Typically, companies issue bonus shares to reduce their share price and increase their investor base by improving their affordability. Equity shares can also participate in a rights issue when a company allows its existing shareholders to buy its shares at a lower price. Preference shares do not get bonus shares. Also, they do not get the rights to buy equity shares if the company is giving a rights issue.

Face Value

Most equity shares in India have a face value of INR 10. On the other hand, preference shares have a higher face value of INR 100 or INR 1,000. Note that the face value is different from the market value of the company. Due to their higher face value (e.g., INR 1,000), preference shares can be unaffordable to small-scale investors.

Type of Investors

As we have seen, preference shares get preference in payments of dividends and claims on assets in case of bankruptcy. These features make preference shares attractive to risk-averse investors. On the other hand, equity shares are more attractive to investors willing to take risks. 

Examples

Every public company listed on leading stock exchanges has issued equity shares. Preference shares are relatively rare. In the recent past, companies like Tata Capital and IL&FS have issued preference shares.

The differences between equity and preference shares are summarised below for your ready reference.

Characteristic Equity Shares Preference Shares
Issuance Mandatory Voluntary
Dividend payments Not fixed Fixed
Order in claim on assets Lower Higher
Voting rights On all key decisions Only on selective decisions
Variety/types
  • Ordinary equity shares
  • Differential Voting Rights (DVRs)
  • Convertible/Non-convertible
  • Cumulative/Non-cumulative
  • Participatory/Non-participatory
Trading on exchanges
  • Trade on exchanges like the BSE and the NSE
  • Highly liquid
  • Trade in the OTC market
  • Less liquid
Buyback options for the company Possible under share buybacks Possible for redeemable preference shares
Rights for shareholders Voting rights No voting rights, but several other rights
Face value INR 10 per share in most cases INR 100 or INR 1,000 per share
Types of investors Attractive to investors willing to take risks Attractive to risk-averse investors

Conclusion

Both equity and preference shares have their own advantages and disadvantages. For first-time investors, equity shares are a good way to get started. These shares can be purchased with relative ease and have a liquid market. Risk-averse investors can invest in preference shares through the OTC market.


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Understand the rules for investing in Equity

 

Getting equity exposure is about following the rules for holding the portfolio to see index-plus returns( high returns). Take a considerate decision on investing in Equity and understand that equities are the best way to create wealth.

Rules for investing in Equity:

  • Have the patience to see consistent returns. If you buy equity with a holding period of 10 years, you’ll be able to see interesting returns(positive returns) in the 7th year of your investing. This happens because the fluctuation in the returns will start reducing and then on average, you’ll see returns that will above 14-15% per year. Thus, have the patience to have investments in the long term.
  • You’ll be at risk if you choose a poor product. If you opt for a poor product with a long holding period and later you find yourself that you did worse than the average product in the market. So, be careful while choosing a product and be very particular about your risk bearing capability.
  • What if you find out yourself frozen in choosing Equity products. Firstly, understand the Equities completely.

There are 3 ways to buy equity:

  1. Direct stock
  2. Market-linked products(ULIP’s)
  3. Mutual Funds.

You can invest in Equity Funds through Finity. They are professionally managed by expert professionals who spend quality time researching the performance of these funds.

The benefits include:

  1. You can invest in Equity Mutual Funds that have provided returns >15% for the past 5 years.
  2. They offer you an opportunity to redeem your investments at any time (Except for Equity Linked Saving Schemes-‘ELSS’ which has a lock-in period of 3 years).
  3. Equity mutual fund schemes avail you a facility to invest small sums at regular intervals through systematic investment plans (SIP).
  • Do not invest in any product that locks you in a particular company or asset manager. Always opt for the product where the “Exit” is possible with an easy and cheap procedure. And also look for the “portability” where you should be able to move your money more easily to a better fund investment with minimum cost.
  • If you want to manage your funds by yourself, start learning about the products through online platforms and try to look in the records to know how the funds are performing over the years, and then invest. Always remember, “Not investing in Equity” is not your option.

Thus, put your money to work for the long term. If you’re a good financial planner then you would have already planned for your Emergency funds and medical cover. So, you have taken away the need for keeping money in liquid and you can risk investing in Equity Mutual Funds.

 

Here, you have the best platform -“Finity” to invest in Equity Funds and create wealth for the long term. Use Finity to discover, track and invest in Equity Funds.

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Understanding Stock Index

Stock Index is the “performance measurement” section of the stock market. Among the stocks listed in the stock exchange, some similar stock is grouped to form an “index”. And this grouping is done on the basis of certain characteristics like the size of the company, sector or the industry to which it belongs to.

The value of an index is calculated by using the value of the grouped stock ( weighted index method). Thus, any changes in the price of the stock will lead to a change in the index prices. The index is “an indicator” of price change in the stock market which will help “traders” to track the market and calculate the returns on a specific instrument.

When will the Index raise?

In the stock market, prices of some items in an index will go up and down- these ups and downs in the prices will get canceled, whereas price rise on an average is more than the price fall, then the index will rise and we say inflation is rising and vice-versa.
For example, you may buy something in the market which may not reflect the trend of inflation. You go buy milk and find that the price has gone up. But, the index may be down because the price fall in fuel and other things have canceled out the price rise in the milk.

Most of the trading of Indian stock takes place in BSE (Bombay Stock Exchange) and the National Stock Exchange (NSE). In India, the BSE Sensex and NSE Nifty are considered as benchmark indices to evaluate the overall performance of the market.

What is Sensex?

For a better understanding of what is Sensex, let’s take an example of the Indian hockey team. If someone says “Indian hockey is in great form and expected to win against England”. Does it mean that every Indian can perform better than England players?
No, what actually means is that Indian players who are representing our country are performing well and there are expected to win over the other country.
Now taking this as a basis, there are the top best 30 countries that are listed in BSE (Bombay Stock Exchange) that are representing the country’s economy. The index is formed taking the stock prices of these 30 companies on a pre-defined basis and it is called “SENSitive indEX”(SENSEX) which means that they are so sensitive to price change. When we say Sensex went up, it means that the prices of these 30 companies are gone up rather than fall and vice versa.
The same happens with Nifty. Nifty is a market indicator of NSE. It has a collection of 50 stocks, but presently it has 51 listed in.

What is Market Capitalization?

Now, let’s learn about market capitalization. Market capitalization (market cap) is calculated by multiplying the outstanding shares of the company to its current market price per share. Companies that are traded in the stock market are grouped into different categories. For example:

     Index Companies
Large-cap index This index will keep track of the prices of large-cap companies.
Mid-cap index The index tracks only the representatives of mid-cap companies.
Small-cap index This index will track the firms which are even smaller than the mid-cap companies.
Bankex index Tracks the stocks which are traded in the banking sector.
PSU index Tracks the prices of PSU(Public Sector Undertakings).
Technology index It will map the prices of tech-related firms.
Infra index Tracks the prices of infrastructure-related stocks.
FMCG index Tracks the prices of Fast Moving Consumer Goods (FMCG).

Why stock prices go up?

Stock prices go up in the long run because as you know that the firms which are listed in the stock exchange trade their goods and services to make good profits and those companies will see good growth. Thus, rising prices reflect the growth and performance of the company.     

Are stocks are the best route to get inflation-adjusted returns?

When inflation rises, the input cost of the firms will also rise. But, the company will not bear the entire cost. Instead,  this cost will be passed on to the customers in the form of prices. So rise in the input cost will not affect the companies profit. Thus, we can say that stock gets protection from the effect of input price inflation.

Is investing in stock is complex?

Before investing in stock, you have various factors to consider such as size, sector, structure, etc.

All these factors are compared with the macroeconomic conditions in order to assess the capability of fund performance. So, there are speculators who will do this. As an investor, your only job is to invest your hard-earned money into the stocks and you have speculators, whose job is to track the market moves.

Thus, investing in stocks through Mutual funds is more advisable. You can get a wide range of benefits by investing in mutual funds.

Finity is one such platform where you can get access to a variety of funds in just one app.“Finity”, which helps you select the right Mutual Fund according to your investment horizon, risk appetite, and financial necessities.

 

Start your investments with Finity- the best platform for investments.

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What is Market Capitalization?| What are it’s Implications?

Description :

TRANSCRIPT:

Hi guys. So today let’s talk about the term you would have heard about or even read in your bank newspapers the term is market capitalization.

So what is market capitalization? To put it in a simple way market capitalization is nothing but the value of a company as reflected by the stock market.

So how is this market capitalization computed? It is a rather simple formula so it comprises of two basic components. one we share price of a company and two the number of stocks of the same company that are traded on this stock market. So let me break it down to you with a simple example: Let’s say there is a company whose share is worth rupees thousand a share and let’s say there are a crore shares that are traded on the market of the same company the market capitalization is simple it is a thousand rupees multiplied by the crore outstanding shares in the markets which comes up to a thousand crore.
So in this entire example the thousand crore becomes the market capitalization of the company generally larger the market capitalization the bigger the business value is assumed to be.
Now that we have taken a look at all that there is to know about market capitalization let’s take a look at the next point that is how do mutual funds define these stocks so let’s do it with a simple exercise imagine the entire list of stocks listed on the stock exchange in an order in descending order from top to bottom in other words let’s say the stock at number one is the stock that has the highest market capitalization and the last ranking stock has the lowest market capitalization now let’s break this into sections the first section is the section of stocks ranking from number one to 100 these are large cap stocks large cap stocks are huge in size these are practically the top hundred stocks by market cap as you would understand they have a relatively stronger business model and their size is too used to be impacted by smaller volatility Xindi market.

Next the list of stocks that ranked from 101 to 250 qualifiers mid cap stocks now mid cap stocks are not as stable as large cap stocks they have a higher amount of volatility but alongside it has a higher growth potential as it graduates from mid cap stocks to a large cap stock sometime in future next the entire lot of stocks that rank below the 250th ranked qualifier small cap stocks these stocks are the most volatile out of this entire list but having said that along with the volatility the scope of growth is even higher as it graduates from small cap stocks to increasing its value to a mid cap stock and sometime hopefully in future as a large cap stock generally mutual funds classified these stock universe as for large mid and small caps and the volatility keeps going up as you move lower in the pyramid.
Here’s the bottom line market capitalization is a good indicator of the size of a business and also higher the market cap it is assumed to have lower volatility however this is not an indicator to be observed in isolation as it does not include various other factors as the debt component of the company the business threads etc but having said that it is a good primary indicator for anyone looking to cap or increase their volatility exposure into the stock market basis the market capitalization.