The financial year of 2021 in India saw a spurt in the number of retail investors, reaching 142 lakhs. After the pandemic-induced crash of 2020, the Sensex clocked in its record high at 62,245 and Nifty touched its peak of 18,604. In other words, Sensex and Nifty rallied 139.57% and 144.45% respectively after the crash in March 2020.
This show of resilience and growth on returns boosted confidence among investors, as is evident by the 12.9% of total investments in India that are held in stocks or equities. This welcomed growth has led to the need to increase awareness among investors on what exactly are shares and the different types of shares available. Here is more about Retail Investor’s Guide.
What are Shares?
Simply put, shares represent a unit of ownership of a company. Let’s say a company is worth ₹1000. Then the company may issue 100 shares at the value of ₹10 each. The owners of these shares may also be entitled to dividends and be bearers of profits and losses. Now, depending on certain characteristics there are different kinds of shares one could be offered – such as preference shares, equity shares, and Differential Voting Rights shares (DVRs)
Decoding Equity Shares
Equity or ordinary shares are the most common types of shares issued by a company. These shares are actively traded in secondary or stock markets and shareholders are entitled to voting rights and may also be entitled to dividends. However, dividends on these shares are not fixed and may vary year-on-year and are based on the company’s performance. In fact, equity shareholders receive shares only after preference shareholders do.
There are several advantages to investing in equity shares like having your capital actively appreciate as the market grows. Based on the demand and supply of shares that are listed on stock exchanges, their prices too go up and down. Let’s say you buy shares of a company dealing with renewable energy for ₹100 and the demand for the share increases owing to government regulations.
Let’s assume the value of each share increases to ₹150. Now if you bought 100 shares worth ₹100 each, your total investment would be ₹10000. And with demand going up your profit alone would be ₹5000 or 50% – much higher than what one could expect on a fixed deposit in a bank.
Another reason why individuals prefer investing in equity shares is because of dividends. If a company has a track record of incurring profits and chooses to pay out dividends then this can become a source of regular income for shareholders
Understanding Preference Shares
Holders of preference shares, as the name suggests, are treated preferentially. They are prioritised when it comes to receiving dividends but may not have the same level of voting rights as those who own common stocks.
There are four main types of preference shares. The first one is cumulative shares. Owners of these shares are entitled to receive dividends that were not paid previously, in the future. The dividend payout for cumulative shareholders is prioritised over common shareholders. The second type of preference shares is known as non-cumulative shares.
These shareholders are not entitled to dividends they were not paid in the past. This is what makes cumulative shares more expensive to own than non-cumulative shares. The third category belongs to participating preferred shares. In this case dividend payout depends on achieving certain performance targets such as profits. Lastly, convertible preference shares allow holders to convert their preference shares into common shares at a specified exercise price.
In case a company goes bankrupt, different security holders within the company can claim the company’s assets. However, the order in which investors receive their portion of assets varies depending on the rights mentioned in their security agreements. In this regard, preference shares usually have a higher priority than other fixed-income securities, corporate bonds or debentures.
What are Differential Voting Rights
DVR shareholders are given diluted voting rights when compared to equity shareholders. But in return companies tend to pay out a higher dividend rate and get shares priced at almost 40-30% below their equity share equivalents. This allows investors to invest small amounts while enjoying incremental and sometimes quick returns if the company does well in the future. For companies, it allows them to raise capital without truly watering down the ownership structure while creating new cash flows to fund new projects.
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