Equity means ownership. In the stock market, it is the stake in a company that a share represents. On a balance sheet, shareholders' equity is what is left after all debts are taken off assets. As an asset class, it is the part of a portfolio held in shares rather than bonds, deposits or gold. Equity holders take the most risk. Over long periods they have earned the most.
Equity has three related meanings, and all three come up in investing. The first is ownership of a company. The second is a line on the balance sheet. The third is an asset class.
Equity as ownership
When a company issues shares, it sells slices of itself. Each equity share is one slice. Hold 1,000 shares of a company with 10 crore shares and the stake is 0.001% of the business. That stake carries a vote at shareholder meetings. It carries a claim on dividends when the board declares them. And it carries a share of whatever is left if the company is wound up.
Equity shares are the ordinary shares that trade on the NSE and BSE. Preference shares are different. They pay a fixed dividend and rank ahead of equity if the company is wound up, but usually carry no vote. How a company's capital is divided is covered in types of share capital. The two kinds of shares are compared in equity shares vs preference shares.
Equity on the balance sheet
Shareholders' equity, also called net worth, is total assets minus total liabilities. It is the book value of what the owners would hold if the company sold everything and paid every debt. It is made up of the share capital the company raised, plus reserves. Reserves are mostly profits kept back over the years instead of being paid out.
A company with assets of Rs 5,000 crore and liabilities of Rs 3,000 crore has equity of Rs 2,000 crore. Divide that by the share count to get book value per share. That is the bottom half of the price-to-book ratio. Return on equity is net profit divided by shareholders' equity. It shows how well the company uses the owners' money. A return on equity that stays above 15% is widely read as the mark of a good business.
Equity as an asset class
In portfolio terms, equity is money in shares. Debt is money lent out through bonds and deposits. Equity is the riskier of the two. A lender is promised a fixed interest payment and gets paid first. An equity holder is promised nothing and gets paid last. In return, equity holders own all the upside. A business that doubles its profits pays its lenders the same interest as before. The extra belongs to the owners.
That is why equity has beaten debt over long periods. The Sensex has grown at roughly 15% a year since its 1979 base, against single-digit returns on deposits. It is also why equity falls hardest in a bear market. Planners tell investors to hold it only with money they will not need for several years.
Ways to hold equity
Direct shares bought through a broker are the most hands-on route. Equity mutual funds and index funds pool money and spread it across dozens of stocks. A SIP into an equity fund is how most Indian households now hold equity. Exchange-traded funds trade like shares but hold a basket. Employees sometimes get equity through stock options. The right mix depends on how much time the investor has to research and how much volatility they can sit through.
Equity for a trader
On a trading platform, "equity" usually means the cash segment. That is buying and selling shares for delivery or intraday, as opposed to futures and options. Equity delivery trades settle on T+1 and the shares land in the demat account. Intraday equity trades are squared off the same day. They are the only way to short a stock without using derivatives. Shares held in the portfolio can be pledged as margin for F&O. So a long-term equity holding and an active derivatives book can work together.
FAQs
Is equity the same as a share?
Close. A share is the unit, equity is the ownership the shares add up to. In everyday use the two are swapped freely.
What is negative equity?
When a company's liabilities exceed its assets, so shareholders' equity on the balance sheet is below zero. It usually means years of losses have wiped out the capital and reserves.
Why is equity called risk capital?
Because equity holders are paid last. If the company fails, lenders and preference holders are settled first. Equity holders get whatever remains, which is often nothing.
How much equity should a portfolio hold?
There is no single answer. A common starting point is to hold more equity when the money will not be needed for ten years or more, and less as the goal gets closer.