Shares and investing are almost synonymous in the world of personal finance. Experienced and amateur investors alike swear by investing in shares for high returns, capital growth, dividend income, and several other benefits.
But what does it really mean to invest in the shares of a company? And what are the different types of shares in India that you can add to your investment portfolio to achieve your financial goals? Read on to find out.
Table of contents
1. What are shares?
2. What are the various types of shares?
3. Types of equity shares based on share capital
4. Types of equity shares based on features
5. Types of equity shares based on returns
6. Types of preference shares
7. Things to keep in mind before investing in the share market
8. How to invest in the share market?
9. Frequently asked questions
1. What are shares?
When a company wants to raise money, also known as capital, it can do so in two ways. The first is to take a loan from a financial institution and add some debt to their balance sheet. The other is to offer a part or unit of the company to investors in exchange for money. A single such unit of a company that is offered to investors is known as a share or an equity stake.
A company that has taken a loan needs to repay it at the end of the loan tenure. During that tenure, it also needs to pay interest to the lender. In contrast, however, capital raised through shares (known as share capital) doesn’t need to be returned, as the shareholders become part owners of the company. Moreover, there are no interest payments to be made on share capital.
Once an investor has bought shares of a public company, they are free to sell them in the secondary market, i.e. the stock market. Note that for our purposes, the terms ‘share’ and ‘stock’ will be used interchangeably, and essentially mean the same thing — a unit of stake or ownership in a company.
Companies can issue different types of shares, with each type having different features and being meant for specific purposes. By understanding types of shares, you can assess which type will benefit your portfolio the most.
2. What are the various types of shares?
Shares can broadly be classified into equity shares and preference shares.
2.1 Equity shares
Equity shares are the most common type of shares that investors invest in. Most of a company’s capital is also generally raised through equity shares. As an equity shareholder, you get voting rights when it comes to electing board members — one vote per equity share owned. While this might not matter much for retail investors whose equity shares in a company generally don’t translate to even a 1% stake, for larger shareholders, this means they get to have a say in the company’s management and policies.
Equity shareholders have a claim on the company’s profits but don’t get guaranteed returns. This means that if the company does well in a financial year, the board of directors have the discretion to decide whether or not to declare dividends and at what rate. However, equity shares are still one of the most preferred types of shares to invest in. This is because, other than dividend income, they also provide the opportunity for capital gains through stock value appreciation.
In the event of a company becoming insolvent, equity shareholders are last on the priority list. First, the company prioritises paying back its debt and clearing all liabilities. Then, it focuses on paying back holders of preference shares, discussed below. Finally, if any money is left over, then equity shareholders get paid.
2.2 Preference shares
Preference shares are called thus because such shares come with certain preferential rights. Firstly, preference shares tend to come with a fixed rate of dividend, and preference shareholders are given priority over equity shareholders when it comes to dividend payouts. Secondly, as mentioned above, in the event of insolvency, preference shareholders are prioritised over equity shareholders for capital repayment.
However, unlike equity shares, preference shares do not come with any voting rights. Additionally, some types of preference shares do not come with a claim on the company’s profits. This would mean that even if a company performs exceptionally well in a financial year, preference shareholders might only receive the predetermined dividend, whereas equity shareholders will get to participate in the company’s profits.
In terms of price movements, preference shares tend to be more like bonds (a different asset class) rather than equity shares. They are especially impacted by changes in interest rates — preference share prices fall when interest rates rise and vice versa.
Both equity and preference shares are further classified into different types of shares based on several factors, and it’s important to understand their features to know what kind you should invest in.
3. Types of equity shares based on share capital
The share capital of a company comes under the heading “shareholders’ funds” in the balance sheet of a company. On the basis of the process of raising share capital, equity shares are classified as follows:
3.1 Authorised share capital
Authorised share capital is the maximum amount of share capital that a company can issue to shareholders as per its Memorandum of Association (MoA) (or a similar corporate charter). The authorised share capital can be increased or decreased, if required.
3.2 Issued share capital
Companies tend to issue authorised share capital in tranches depending on their need for funds, instead of issuing it all in one go. The capital corresponding to the portion of the authorised share capital that the company actually issues to investors is called the issued share capital.
3.3 Subscribed share capital
The subscribed share capital is that part of the issued share capital for which a company has received applications from investors who are interested in buying its shares.
3.4 Paid-up share capital
Once the company has received subscriptions from shareholders, it decides to “call” a part of the subscribed share capital from those shareholders. This means those shareholders are supposed to pay the company the face value of the shares. The paid-up share capital is the amount of money the company has actually received for its shares.
4. Types of equity shares based on features
There are certain types of special issues of shares that are relevant to the existing shareholders and employees of a company. These include:
4.1 Bonus shares
A company may issue additional shares to its existing shareholders free of cost; these are called bonus shares. A company usually issues bonus shares when it’s unable to pay dividends to its shareholders or when it wants to convert a part of its retained earnings into shares.
4.2 Rights shares
Rights shares are the shares that a company offers to its existing shareholders at a price that may be discounted for a specific period before it issues its shares to the public at large. The existing shareholders have the right to accept or reject rights shares proposals.
4.3 Sweat equity
Sweat equity shares are the shares that a company issues to its employees as a form of compensation, in addition to their salary, for their effort and contribution to the company.
5. Types of equity shares based on returns
The primary purpose of investing in shares may either be to earn dividends or to benefit from capital gains by eventually selling the shares. Hence, on the basis of the kinds of returns one expects to earn from shares, equity shares can be of the following types:
5.1 Dividend shares
Dividend shares are shares of those companies that are known to pay their shareholders regular dividends. Since a company is not required to pay dividends to shareholders, many companies reinvest their profits into the business instead of paying dividends. However, there are some well-established companies with strong financial fundamentals that regularly pay dividends to their shareholders. Investors looking to set up a passive source of income for a regular inflow of money tend to opt for dividend shares.
5.2 Growth shares
Growth shares are shares of companies that have significant growth potential, and whose sales and earnings are expected to outperform the industry average in the future. Growth stocks generally do not pay dividends to investors, and any profits earned by these companies are reinvested back into them to accelerate their growth. Technology stocks, such as Amazon and Microsoft, are excellent examples of growth stocks.
Investors buy growth stocks with the expectation that their value will increase significantly over time, allowing them to earn huge profits, or capital gains, at the time of selling the shares.
5.3 Value shares
Value shares are shares that are undervalued in the market when compared to the company’s financial fundamentals. Usually, they are shares of well-established companies that are going through a setback in the short term for a specific reason, like negative publicity due to a lawsuit. They offer a good opportunity for investors to add strong stocks to their investment portfolios at discounted prices. Value stocks also tend to pay regular dividends.
6. Types of preference shares
Preference shares, while not as popular as equity shares, make for good investments for conservative investors. Preference shares in India are primarily of the following types:
6.1 Cumulative and non-cumulative preference shares
Cumulative preference shares come with a clause that requires the issuing company to pay shareholders dividends in arrears. For instance, say in a particular financial year, a company owes Rs 10 in dividends per cumulative preference share, but due to lower profits, it could only pay Rs 5 per share. In such a scenario, the remaining dividend of Rs 5 per share will be “accumulated”, and the company will be liable to pay it to its shareholders in the next financial year, or whenever there is sufficient profit, along with future dividends.
In the case of non-cumulative preference shares, the unpaid dividend does not get carried forward and investors simply lose out on it.
6.2 Participating and non-participating preference shares
Generally, preference shares come with a fixed rate of dividend beyond which their holders do not have a claim on the profits of the company. Such shares are called non-participating preference shares. Participating preference shares, however, allow shareholders to enjoy additional profits if a company has an exceptionally good year or when it meets certain financial targets.
6.3 Convertible and non-convertible preference shares
Convertible preference shares are those that can be converted to equity shares after a certain period and as per the conditions mentioned in the MoA of the issuing company. Conversely, non-convertible shares do not have this option, and must remain preference shares at all times.
6.4 Redeemable and irredeemable preference shares
Redeemable preference shares, also known as callable shares, are shares that the company has a right to repurchase or ‘call back’ at a certain price in the future. Conversely, irredeemable shares cannot be redeemed during the lifetime of the company, and investors can only sell them in the secondary market.
Now that you know about the types of shares in India, it’s important to look at some basic things to consider before you invest in the share market.
7. Things to keep in mind before investing in the share market
Investing in the share market can be lucrative. But it can also be risky since shares are a high-risk asset class. The share market is characterised by inherent volatility — i.e. frequent changes in price. This volatility is a double-edged sword, because when the prices of your share investments increase significantly, you can sell them and earn great profits. However, if the prices fall significantly, you can lose your capital too.
This is also why investments in the stock market should be undertaken with a long-term perspective. Even if the prices of a stock fall, chances are that price drop is a short-term one, and the stock will potentially recover over time. Hence, if you keep your money invested, you don’t have to book any losses.
Another thing to keep in mind is diversification. It’s not wise to buy shares of only one company or of companies belonging to only one industry. If you have a diversified portfolio, when one of your investments in a certain sector or company doesn’t perform well, your investments in other sectors or companies can make up for it and stabilise your overall portfolio returns. You can also diversify by investing in shares indirectly and by investing in foreign stock markets.
8. How to invest in the share market?
You can invest in the share market either directly by investing in the stocks of individual companies, or indirectly through investment products such as Exchange-Traded Funds (ETFs) and mutual funds. Such products offer inherent diversification along with benefits such as professional management of funds and convenience.
To invest in the share market, you need to choose a broker or investment platform that is registered with the Securities and Exchange Board of India (SEBI). When looking for an investment platform, you should make sure it offers you a seamless way to invest in a range of securities at a low cost. And Appreciate does just that!
With the Appreciate app, you can invest not just in the Indian share market but also in the US share market to add high-performing shares to your investment portfolio. You can invest through Systematic Investment Plans (SIPs) to meet different goals, buy fractions of expensive shares, and automatically invest the spare change from your transactions. So get started with Appreciate today!
9. Frequently asked questions
9.1 What is the difference between shares and stock?
The terms ‘shares’ and ‘stock’ are often used interchangeably, but there’s a slight technical difference between them. The stock of a company refers to the entirety of the units of ownership that it is split up into, while a share is a single such unit of ownership.
Thus, it makes sense for an investor to say that she bought 100 shares of Tesla stock.
9.2 What are Sensex and Nifty?
The Sensex and the Nifty are the most popular stock market benchmarks indexes in India. A benchmark index is a hypothetical portfolio of securities that aims to reflect the overall performance of the stock market as a whole or that of a specific sector.
The Sensex is the benchmark index of the Bombay Stock Exchange (BSE), while the Nifty is that of the National Stock Exchange (NSE).
9.3 What is the difference between IPO and shares?
A share is a financial instrument that you can invest in, and that is issued by a company when it wants to raise funds. When a company issues shares for the first time to the public, this issue is called its Initial Public Offering (IPO). The shares of a company can either be bought through its IPO or later from the secondary market.
9.4 Where can I buy shares?
You can buy shares when they are first issued by a company, i.e., from the ‘primary market’, or from the ‘secondary market’ where shares are traded. Either way, you need to approach a broker or use an investment platform to open a trading or demat account so that you can buy shares.
9.5 How to invest in shares for beginners?
As a beginner, you can start investing in relatively safe stocks, such as large-cap stocks. You can also consider investing through products such as ETFs and mutual funds, where a professional is handling your money and making important investment decisions.
