What Are Equities and How Do They Work?

Equities represent a fundamental component of financial markets, serving as a direct link between investors and companies. These financial instruments signify an ownership stake in a company, allowing individuals to participate in its success. Understanding equities provides insight into how businesses raise capital and how investors can become part-owners, forming the basis for navigating the broader investment landscape and comprehending how companies are structured.

Understanding Equity Ownership

Equity fundamentally signifies ownership within a company. When an investor purchases a share of equity, they acquire a fractional ownership claim on that company’s assets and earnings. As the company grows, the value of the shareholder’s ownership stake tends to increase. This proportional claim extends to the company’s net assets, which are what remains after liabilities are accounted for.

The number of shares an individual owns directly correlates to their percentage of ownership in the company. Owning one share out of a million outstanding shares grants a small claim to the company’s overall value. This ownership can exist in either private or public forms, though this article focuses on publicly traded equities. Public equity refers to ownership in companies whose shares are listed on stock exchanges and are accessible to the general public with an investment account.

Conversely, private equity involves ownership in companies that are not publicly traded. These investments are made by institutional investors or high-net-worth individuals, involving less liquidity and longer investment horizons. Publicly traded companies must adhere to regulatory requirements, such as those set by the Securities and Exchange Commission (SEC) in the United States, which mandate financial disclosures to ensure transparency for all investors.

Types of Equities

Equities fall into two main categories: common stock and preferred stock. Common stock grants owners rights, including potential capital appreciation as the company’s value grows. Holders of common stock possess voting rights, allowing them to influence corporate matters such as the election of the board of directors and significant policy changes.

Preferred stock behaves as a hybrid between equity and debt instruments. While representing ownership, preferred stockholders do not have voting rights in company decisions. A distinguishing feature of preferred stock is its fixed dividend payments, which must be paid before any dividends are distributed to common stockholders.

Preferred stockholders also hold a higher claim on a company’s assets in the event of liquidation, meaning they are repaid before common stockholders, though after creditors. This preference in dividends and liquidation makes preferred stock appealing to investors seeking more stable income streams.

How Equities Generate Returns and Rights

Equity ownership offers two primary avenues for generating financial returns: capital appreciation and dividends. Capital appreciation occurs when the market price of a share increases over time, allowing an investor to sell their shares for more than they originally paid. This gain is realized when the shares are sold, reflecting the company’s improved performance or increased market demand.

Dividends represent a portion of a company’s profits distributed to its shareholders as cash payments. Companies’ boards of directors determine if and when dividends are declared, and common stockholders receive these distributions after preferred stockholders. Dividends provide a regular income stream to investors and can be reinvested to acquire more shares, potentially compounding returns over time.

Beyond financial returns, equity ownership also grants specific rights to shareholders, particularly common stockholders. These rights include the ability to vote on important corporate matters, such as electing board members and approving major business actions like mergers or significant policy shifts. Shareholders may also have a residual claim on company assets in the event of liquidation, meaning they receive a share of any remaining assets after creditors and preferred stockholders have been paid.

Acquiring and Trading Equities

Individuals acquire and trade equities through brokerage firms. These firms act as intermediaries, enabling investors to access the stock markets. Most trading of publicly listed company shares occurs on organized platforms known as stock exchanges, such as the New York Stock Exchange (NYSE) and Nasdaq.

To buy or sell shares, an investor places an order through their brokerage account. A “market order” instructs the broker to buy or sell shares immediately at the best available price in the market. Alternatively, a “limit order” specifies a maximum price to buy or a minimum price to sell, ensuring the transaction only occurs at or better than the desired price. Once an order is placed, the brokerage firm routes it to the appropriate exchange for execution.

Stock exchanges provide a centralized marketplace where buyers and sellers are matched, facilitating the transparent and orderly trading of securities. The prices of shares on these exchanges fluctuate throughout the trading day based on supply and demand. After a trade is executed, the transfer of ownership and funds settles within a standard timeframe, typically two business days, completing the transaction.