Equities – aka shares – represent an ownership stake in a company.

That company could be privately held or publicly traded, i.e., shares that are bought and sold on a stock exchange.

In this piece, we’ll be looking at public equities. 

The owner of an equity, or shareholder, is part owner of a company. They can potentially benefit if the company does well and makes profits.

On the flipside, if the company does badly, the shareholder could even end up losing all their investment.

We’ll look a bit more about how equities make – and lose – money shortly.

As well as potential financial returns, equities can give their owners other benefits: namely, a say in how the company is run. That may mean having a vote on various company matters, including how much gets paid out to shareholders as dividends, who runs the company and whether a company should sell itself to another company. 

Companies sell equities to outside investors for many reasons, first and foremost to raise money.

The money raised can be used for things like business expansion, developing new products, buying other companies or reducing debt.

In some cases, it can be a way for private owners to reduce their own stake in the company or exit entirely.

Having sold their shares to the public on the stock market, companies may then issue further shares to raise further capital in the future, if need be.

In the meantime, having a public listing can raise a company’s profile and reputation. 

If the company is successful and is perceived as such by investors, its shares may obtain a higher valuation.

Not all shares are created the same. Instead, they come in different categories.

Common shares are what most people have in mind when they talk about equities. 

Common shareholders often – but not always – get a vote on company issues.

They may also receive a share of company profits, known as a dividend, if the company decides to pay one.

If the company goes bust and its assets are liquidated, common shareholders are at the back of the line. 

Creditors and other kinds of shareholders have priority if there is any money left to give back.

Preferred shares are an ownership stake in the company but also somewhat like bonds. 

Preferred shareholders are second in line after bondholders to receive dividends, in this case, a fixed amount like a bond.

They also rank ahead of common shareholders for getting money back if the company fails. 

Preferred share prices don’t tend to fluctuate as much as common shares. 

Unlike common shares, preferred shareholders aren’t usually entitled to vote on company policies or corporate actions.  

Convertible preferred shares allow holders to switch preferred shares into a certain number of common shares after a specified date. 

This feature means holders can earn a higher return if the company is successful and the common share price rises.  

Equities produce returns for their owners, which can be positive or negative.

If a business is successful and becomes more profitable over time, its value on the stock market may go up too. 

This can enable the shareholder to sell their shares for a higher price than they bought, resulting in a capital gain.

But if a company struggles, its share price may well go down. 

Shareholders can often see individual investments fall by very large amounts, much greater than the falls across equity indices such as the S&P 500.

And if a company goes bankrupt, investors can lose 100% of what they put in.

Shareholders can also make money if their companies pay out dividends. Many shareholders choose to reinvest these dividends to buy further shares in the same companies. Over longer periods, this can account for a large amount of their overall returns.

Many forces can make equity prices rise and fall.

If the company does well or badly, the shares may do likewise. But there’s no guarantee of this.

When investors in general want to take more or fewer risks, there can be a similar effect on the stock market overall. Many individual shares may get pulled higher or lower on the back of this.

Economic forces can have a big influence too. Changes in interest rates, inflation and economic growth can cause movements in shares.

However, not all shares behave in the same way. Some companies and industries may do better or worse amid the same conditions.

For example, rising interest rates may hurt the prices of some fast-growing firms, such as in the technology industry. At the same time, the shares of banks can sometimes do well under the same conditions.

Multiple forces can combine at the same time to produce perhaps unexpected movements in prices.

Equities are risk assets. They face a broad array of risks, all of which can result in partial or complete losses for investors.

A company may find its main product or service becomes obsolete, it may borrow too much or it may be poorly managed. Such difficulties can cause its share price to fall.

Economic forces beyond its control such as a recession can undermine demand for its product or service.

All equities face risk from the wider stock market going down, which can pull down individual companies’ shares with it, even if there is nothing wrong with the business.

In extreme situations, entire stock markets can become worthless. This is rare, but it happened in China in 1917 and Russia in 1947. 

Alongside bonds (fixed income), shares represent a core ingredient in many investment portfolios. 

Over time, global equity markets have tended to rise by more than inflation.

Since 1957, investors in the S&P 500 Index would have made a total return – capital gains plus reinvested dividends – of more than 10% a year.¹  US CPI inflation over the same period averaged 3.68% a year.²  

Rather than reinvesting dividends, some investors seek to earn an income from their equity portfolios.

They do so either by taking the dividends out or by selling some of their equities each year.

Equities come in many different shapes and sizes and can thus perform somewhat different roles in a portfolio. You can read more about style investing here.