Ordinary Shares: From benefits to risks; all you need to know

Ordinary shares, often referred to as common stock, form the fundamental basis of equity investment. These shares, which provide essential benefits such as ownership and voting privileges, come in various types with nuanced differences. Here’s a brief overview of some commonly encountered variations:

Voting vs non-voting shares: Voting shares entitle their holders to vote and attend shareholder meetings; non-voting shares, on the other hand, usually do not. To raise money, businesses may issue shares with no voting rights, which won’t impact existing shareholders’ ability to vote.

Sweat equity shares: These shares are awarded to management or staff as a perk or incentive, lining their pockets with the success of the business as a whole.

Rights shares: These are recently issued shares that are first made inexpensively available to existing shareholders before being made available to the public. If current shareholders choose to take part in the issuance of new shares, they can do so while maintaining their proportionate ownership stake in the business.

Are there any risks involved?

It is important to be aware of the risks involved before purchasing common stock. To reduce these risks and improve your chances of success in the stock market, you should diversify your investment portfolio across different industries, do in-depth company research, and take a long-term investing approach.

Ordinary shares have the potential to yield significant profits, but there are risks associated with them that should be understood. An overview of important factors is provided below:

Market risk: Market risk is the overall chance that the value of your common shares will drop as a result of a downturn in the stock market. This risk can be increased by variables like political unrest, interest rate fluctuations, and economic downturns.

Company risk: The value of your shares may be significantly impacted by the performance of the particular company in which you have invested. The stock price of a company can be negatively impacted by many factors, including bad management choices, unforeseen financial difficulties, or increased competition from rivals.

Liquidity risk: Shares in smaller or less actively traded companies may occasionally present difficulties in finding a buyer at your preferred price, even though common shares are generally considered liquid investments, meaning they can be bought and sold on stock exchanges with ease.

Volatility: Regular share prices are subject to significant short-term swings, which can be unsettling for investors—especially those with short-term investment objectives.

Dividend risk: As was previously mentioned, dividends are not guaranteed. Businesses may decide to cut dividends or stop paying them altogether, which could have an impact on your projected return on investments.

Loss of principal: In a dire situation, shareholders might lose all of their money if a company files for bankruptcy. Any assets that are left over in these situations are usually given to creditors, which may leave shareholders with little to nothing in recovery.

Benefits of ordinary shares

There are many strong arguments in favour of purchasing common shares, though it’s crucial to keep in mind that there are risks involved. To start with, holding ordinary shares entitles you to a portion of the company’s ownership, accompanied by several significant advantages:

Ownership share: The number of common shares you possess directly correlates to your proportionate ownership stake in the company. As your share count increases, so does your portion of the company’s ownership.

Voting privileges: Common shareholders generally have the opportunity to vote on critical company matters during shareholder gatherings. This empowers you to influence the company’s strategic decisions.

Each ordinary share typically grants one voting right on company issues. Therefore, owning more common shares enhances your voting power, enabling you to wield a more influential voice in decision-making processes.

You can participate in a shareholder meeting even if you are unable to attend in person by casting a proxy vote. This gives you the option to designate another person, usually the management of the company, to vote your shares according to your wishes.

Possibility of increase in capital value: Many investors are attracted to ordinary shares primarily because of the potential for capital appreciation. The price of these shares fluctuates based on market demand and supply, meaning the purchase price today may differ from the selling price tomorrow or later.

A key determinant of share price is the company’s performance. Strong financial results, increased market share, or innovative product developments often boost investor confidence. Consequently, heightened demand for the company’s shares can drive up their price.

Dividend income: Dividends represent a valuable avenue for ordinary shareholders to potentially generate income from their investments. They are essentially a portion of a company’s profits distributed to its shareholders. The decision to distribute dividends, and the amount allocated, is determined by the board of directors, based on the company’s financial strength and future strategies.

Dividends can be disbursed quarterly, semi-annually, or annually, with the amount per share varying according to the company’s performance and dividend history. Although dividends are typically taxable income, there may be tax advantages for qualified dividends that meet specific criteria established by tax authorities. While not assured, dividends can serve as a significant income stream for investors, particularly those seeking regular returns.

In the end, whether to purchase ordinary shares hinges on your personal financial objectives, tolerance for risk, and investment horizon. By thoughtfully assessing the potential advantages and risks involved, you can make well-informed investment choices that align with your financial goals.

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Published: 20 Jun 2024, 11:59 AM IST