Why Are Stocks Called Equities?
Clarify the link between stocks and equities. Understand the fundamental ownership they represent and why these financial terms are often used interchangeably.
The financial terms “stocks” and “equities” are often used interchangeably, leading to some confusion for those new to investing. While they are closely related and represent ownership in a company, there is a fundamental distinction between the two concepts. This article will clarify the relationship between these terms, explaining what each means and why their usage frequently overlaps in financial discussions.
Understanding Equity
Equity represents ownership, or the value of an ownership stake after accounting for liabilities. On a company’s balance sheet, it is often called shareholder’s equity. It reflects the residual claim on assets once all debts have been paid, showing what would be left for owners if a company liquidated its assets and settled its liabilities.
The accounting equation, Assets = Liabilities + Equity, highlights equity’s role as the balancing figure. For businesses, equity indicates financial health, showing the capital linked to its owners. It signifies the net worth of a company from the shareholders’ perspective.
Understanding Stocks
A stock, also known as a share, is a financial instrument representing a fractional ownership interest in a corporation. When an investor purchases a share, they acquire a unit of ownership in that company. This ownership entitles the holder to a portion of the company’s assets and earnings.
Companies issue stocks to raise capital, allowing investors to buy into the business. There are two main types: common stock and preferred stock. Common stock grants voting rights on corporate matters, such as electing the board of directors, and offers potential dividends. Preferred stock usually does not carry voting rights but provides fixed dividend payments and has a higher claim on assets in case of liquidation.
The Connection: Why the Terms are Used Interchangeably
The terms “stocks” and “equities” are used synonymously because stocks are the primary way that equity, which is ownership, is represented and traded in publicly held companies. Equity is the overarching concept of ownership or value, while stocks are the tangible units that embody this ownership. When an investor buys a stock, they purchase a piece of the company’s equity.
Holding a stock means holding equity in a company. This relationship leads to the terms becoming interchangeable in discussions about investing. For instance, the market for trading company ownership stakes is referred to as the “equity market.” The distinction lies in equity being the underlying concept of ownership, while stock is the specific, tradable security that conveys that ownership.
Implications of Stock Ownership
Holding equity through stocks carries several implications for an investor. Stock ownership provides potential for capital appreciation, occurring when the stock’s market price increases. This allows investors to sell shares for more than they initially paid. This gain is subject to capital gains tax upon sale.
Shareholders may also receive dividends, which are distributions of a company’s profits. These payouts are taxed. For common stockholders, ownership includes the right to vote on corporate decisions, giving them a voice in the company’s governance.