Equities (or stocks and shares) are what many people think about when it comes to investing. They have the potential to generate higher returns over the longer term than most other types of investment, so play an important part in most people’s investment portfolios.
Here we look at what they are, their benefits and risks, and how you can invest in them. If you’re looking for more than just the basics, we take a closer look at some of the more technical details, including what affects share prices and how dividends are calculated.
Let’s start with what they are
Equities represent a proportion of the ownership of a company. So when investors buy shares, they become a part owner of that company – a shareholder.
Some companies’ shares are privately held – that means they aren’t openly available for investors to buy. Other companies’ shares are publicly listed on a stock exchange – meaning investors can buy and sell them relatively quickly and easily.
Publicly listed equities are usually classified into certain groups according to:
e.g. UK equities, US equities
- Type of business
e.g. retailers, industrials
- The stock exchange where they’re listed
e.g. London, New York, Hong Kong
If you choose to buy shares in a company, you’ll be entitled to a share of the company’s profits, in proportion to your holding. So if things are going well you can benefit from the company’s growth, although obviously this can work the other way too - if a company is doing badly, you could see your investment fall in value.
As a part-owner of a company, you could also be eligible for extra perks such as discounts on products and services.
How they can make you money
Equities can make you money in two ways. But remember, neither is guaranteed.
This is where value of your investment grows through increases in the share price – known as capital growth.
You receive income from equities in the form of dividends, which are similar to a bonus or extra payment.
Many companies (particularly large, well-established companies) pay out part of their profits in the form of a dividend. But in most cases it’s at the discretion of the company directors to choose how much to pay out each year – and they don’t have to pay out at all. The exception to this is preference shares, also known as preferred stock. If you hold these, you’re guaranteed a fixed rate of dividend.
Generally though, companies have a commitment to pay a dividend to shareholders and a decision not to pay one could do more harm than good. For example, it could indicate problems within the business and lead to a drop in share price.
It’s not all about growth – there are risks
Historically, equities have outperformed some of the safer investments such as bonds and money market-type investments and, if managed correctly, they can be a powerful driver for growth in your investment portfolio.
But this greater growth potential comes with greater volatility, meaning their value can rise or fall sharply at any time and you could get back less than you paid in. Share prices are influenced by various factors, but the main ones are how well a company is doing and overall market conditions.
Equities in different market sectors and countries can perform in different ways at different phases of the economic cycle. So it’s worth considering holding a range of equities – and as part of a wider portfolio of other investments.
How to invest in equities
While you can buy and sell shares direct, it can be risky strategy to have all your money in only a small number of companies. Because of that many people choose to invest through funds. That way your money is pooled with other investors’ money to buy a range of equities. You can also choose funds which include a range of investments, not just equities.
And there’s the added benefit of having an experienced fund manager invest and manage your money for you.
> Find out more about why it's a good idea to have a diversified range of investments.
Read on to find out more about equities.
What affects share prices
As we all know, share prices can fluctuate, sometimes quite considerably. Here are some of the main factors which influence them:
Supply and demandIf a lot of investors want to buy shares in a company, but there aren’t many shareholders looking to sell, this will likely push the share price up. On the other side of the coin, if more shareholders want to sell than investors want to buy then this will likely push the share price down.
A company's performanceIn the UK publicly listed companies have to publish their financial results twice a year. They also have to make what are known as ‘regulatory announcements’, for example if they launch a new product or there’s a takeover bid.
As investors use this information to help decide whether to buy or sell shares, this can affect supply and demand and, in turn, share prices. Reports from external research analysts can also increase or decrease demand for shares in a particular company, and affect the share price.
Economic environmentCompanies are more likely to perform well in a healthy economy, leading to increased investor confidence and demand, and rising prices. On the other hand, weak economic conditions can see even robust businesses struggle, meaning reduced investor confidence and demand, and falling prices.
You can track the dividend policy of a company, using what’s known as the ‘dividend payout ratio’. This lets you see how much money a company is returning to its shareholders, versus how much money it’s keeping to either reinvest in growth, pay off debt or add cash to reserves.
If you’re looking for income from your equity investments, then companies with high dividend payout ratios will be more attractive. On the other side, if your primary aim is capital growth, companies with lower dividend payout ratios may be more attractive.
You can also tell a lot about a company from its dividend payout ratio. For example, if a company is maintaining dividend payouts at the expense of reinvesting for growth, could that hamper future prospects and potentially the share value? This is particularly important if capital growth is most important to you.
This information is to help you understand more about equities, how they work and why you might want to invest in them. Please remember though that the information here shouldn’t be regarded as financial advice. The value of any investment can go down as well as up and may be worth less than was paid in.