Table of Contents:
- What Is Equity in Stocks?
- How to Calculate Equity
- How to Invest in Equities
- Risks of Investing in Equities
- The Bottom Line
The term equity can mean different things depending on the context in which its used. For example, when discussing real estate, it means having equity in your home, which is the cash value you would receive after its sold. In legal terms, it means being fair and impartial.
It probably wont surprise you to learn that, in the world of investing, there is also more than one definition for equities.
So, what are equity investments? And what do you need to know before investing in them? Lets get into it.
Key Takeaways:
- Equity is the monetary value of a business after all debts have been paid. It signifies ownership and the right to enjoy future profits, appreciation of a company, and voting rights.
- Equity investments can provide investors with ownership in either public or private companies, along with the rights that come with being a shareholder.
- To calculate a companys equity, use this formula: Assets – Liabilities = Net Worth.
What Is Equity in Stocks?
Equity is the monetary value of a business after all debts have been paid. Equity signifies part ownership in a company and the right to enjoy future profits, appreciation, and voting rights.
For those who are new to equity investments, its important to understand equity as it relates to stocks. When you buy stock, you become part owner of the company. Your equity in that stock then becomes how much money you would receive after all debts were paid and the company was liquidated.
Types of Equity
There are three types of equity youll want to understand:
- Publicly traded Equity (aka equities) refers to owning shares of stock in a company.
- Private equity describes ownership in a private company. This type of equity consists of investors that invest directly in private companies.
- Shareholder equity is the amount of equity a corporations owners have left after liabilities or debts have been paid.
What Are Equity Investments?
When you have equity in a company, it refers to the value of the shares you own in that company. Therefore, an equity investment is money that an individual chooses to invest in a company by buying shares of it on a stock market.
When you invest in equities you have an opportunity to generate high returns on those investments over time, which is just one of the many reasons to invest. Other benefits of equity investments include:
- The opportunity to receive regular payments from dividends on stocks that provide them.
- The ability to diversify your portfolio, which can lessen your risk. Having several types of investments in different industries helps investors avoid an all of your eggs in one basket scenario.
Private Equity vs. Stock
Although it can be somewhat confusing, there is a difference between private equity and stocks.
Stock is a security that provides part ownership of a company or corporation, which entitles the stockholder to a portion of the profits. In other words, stocks are equity shares that are traded on a stock exchange to the public.
Private equities, on the other hand, are sold privately to shareholders looking to invest in a private company.
The chart below shows the differences between the two.
| Private Equities | Stocks |
|---|---|
| – Not listed or traded on a stock exchange | – Traded on a stock exchange |
| – The general public doesnt participate in buying private equities | – Involves the public as they buy on a stock market |
| – No price fluctuations as they arent traded | – Daily fluctuations due to trading activity |
| – Stocks are listed and traded on a stock exchange |
The differences in private equity vs. stock can be challenging to understand. Still, as you can see, they are significant.
How To Calculate Equity
When calculating a companys equity, youll want to have all assets and liabilities available to ensure your calculations are correct. You do this by using the company’s balance sheet, which includes all of the information you need to see the debt to equity ratio. Total assets would include:
- Current assets Cash, receivables and inventory that can be liquidated within a year.
- Long-term assets Patents, equipment, building, pensions, bonds, and any intangibles that couldnt be converted within a year.
Once you have the information, you subtract the total of all liabilities from the total of all assets to find the companys net worth.
Formula: Assets – liabilities = net worth.
When you hear the term shareholders equity, its referring to the companys net worththe money available to its stockholders after all debts have been paid.
How To Invest in Equities
When you start investing in equities, youll want to take the first steps any investor would take to start investing in stocks.
- Open an investment account
- Determine your investment goals and time horizon (basically the period of time an investor is willing to wait until they need their money back)
- Set up a budget
Research Industries and Companies Youd Like To Invest In
As we mentioned earlier, stocks are shares of securities that show ownership in a company that has the ability to grow over time making that investment more profitable to the stockholders.
Once you have a trading account set up, youll want to learn more about how to invest in stocks and have the ability to buy and sell stocks easily through that account.
Before making any decisions, think about what goals you have and research companies that align with those goals. Deciding in advance how much money to invest is also important, as you only want to invest money you dont need right away.
Investing in the stock market offers several advantages, which include:
- The potential for higher returns – Although stocks can come with higher risks, they also have the potential for higher returns so you want to determine your tolerance for risk and invest in companies that are aligned with your investing style.
- An abundance of stock choices – With so many stocks available, you can find a variety of industries with great potential for growth over the long term.
Before jumping in you may want to ask yourself, how do stocks work? Its important to understand the basics so you can make sound decisions.
Invest Through Mutual Funds
Mutual funds are investments that allow small investors to pool their money togethers, allowing them to buy a collection of investments, such as stocks, bonds, and other securities that would be difficult to buy on their own, which creates a diversified portfolio.
Mutual funds are a popular choice for investors due to the many benefits derived from them. The fact that they can help shareholders meet a variety of financial goals is just the tip of the iceberg.
Additional perks include:
- Access to professional money managers whose job is to research, analyze, and select the best investments, leaving the difficult part in their hands. This gives you the benefit of their expertise and allows you to work with professionals without the high costs.
- Easily diversifying your portfolio, which reduces your risk. When you invest in companies across various industries, theres less chance of one investment derailing your goals.
Benefits of Investing in Equities
Investing is a vital part of growing wealth over time. When you evaluate investing and why its a good choice, you cant help but notice two significant benefits:
- Investing holds a higher potential for beating inflation. Inflation is nothing new, its been the one constant in the world and seems to have a life of its own. However, when you make smart investment decisions, you are able to watch your money grow, allowing you to have a financial nest egg for when you retire.
- Compound interest. Investing provides an opportunity to increase the value of the original amount invested significantly as the companys value rises over time. Payments occur from both capital gains and dividends.
Risks of Investing in Equities
While there are some great benefits to investing, you will also want to be aware of the potential risks. Whether we like it or not, investing itself is a risk so youll want to pay attention to the following:
- Fluctuating prices. Prices can change without any understanding of why and as an investor, you need to roll with it without becoming emotionally involved, which can lead to bad decisions overall.
- Not diversifying your portfolio. Its risky to put all of your money into one stock, hoping to hit it big. Diversifying your portfolio lessens risk and allows you to think long-term.
The Bottom Line
Equity investments can provide investors with ownership in either public or private companies, along with the rights that come with being a shareholder. Owning common shares in the stock market provides more availability in investment choices than with private companies, but both offer different advantages.
While public companies have more detailed financial reporting requirements, faster liquidity, and are easy to buy shares of, private equities can be less stressful, as they dont fluctuate the way stocks do on a daily basis.
Overall, investing offers so many benefits, but keeping it simple is more realistic for the average individual investor. If youre ready to get started, download the Public app today.