What is equity? You hear this word everyday, when you watch business news channels, when you travel in local train or in any other situation, but what is it exactly?
Equity is defined as stock or any other security representing an ownership interest in a company listed on the stock exchange.
An equity share is a right to a share in the profits of a Company. If you want a share in the company’s profits, you can do so by buying an equity share.
Perhaps, the best way to create wealth, it is a means to achieve returns that beats inflation by a wide margin.
Tax structure on income from equity investment
Dividends received are tax free. Equity investments are subject to short term capital gains (STCG) and long term capital gain (LTCG) also, as the case may be
Dividend received on stock is free from tax for the investor. This is the good news. However, you do have to pay short-term capital gains tax on any capital gains you might make in the short term (‘short term defined as any period less that one year)
Thus gains from selling equity shares that have been purchased and sold within a year are taxed at 11.22% (10 per cent tax + 2 per cent education cess + 10 per cent surcharge, if applicable). There is no tax on long-term capital gains.
All this is over and above the 12.24% service tax you pay on brokerage charges every time you transact business in equity, i.e., buy and sell shares. In addition, you have to pay Securities Transaction Tax (STT) on sale and purchase transactions of shares.
The STT rate for delivery-based transactions is 0.125% of the transaction value for both buyers and sellers. For non-delivery based transactions, the STT is 0.025% of the transaction value.
Market risks: The risk of market collapse; or that you have invested at the peak of a particular stock. Which means chances are returns on that investment could be minimal at best or worse, will run at a loss.
Equity investment costs
The charges applicable on equity investments are Brokerage, demat, security transaction tax, Service tax and education cess.
Risks inherent in equity investing
The risk factor in equity investments is appreciably higher than fixed income securities such as fixed deposits or National Saving Certificates, or post office monthly income schemes.
Like any avenue of investment (except those whose returns are guaranteed by the government, like the PPF), equity investing comes with risk. In fact, the risk factor in equity investments is appreciably higher than fixed income securities such as fixed deposits or National Saving Certificates (NSC), or post office monthly income schemes.
Company stocks are susceptible to risks, and these risks are carried forward to your investments as well. Here are a few:
Business risks: The risks associated with the prosperity of a business and the demand for its products. There is always a risk that buyer profile or habits might change suddenly and a company’s product goes from being the rage to an also-ran.
Financial risks: The skill with which a company’s finances are managed to ensure that it has an optimum level of debt, equity, reserves, etc. If a company’s financials are ineptly handled, even in the short term, chances are that the ineptness will show up as a run on the stock in the future.
Industry risk: Changes in technology, regulations, vogue, etc. can affect the performance of an industry sector as a whole, and a company stock of that sector might take the fall along with all its other competitors in that sector.
Management risks: The level of corporate governance, management skills and vision determines the long term health of a company. Short term, ad hoc management decisions to ramp up profit sheets invariably leads to long-term grief for that company.
Exchange rate risks: These factors affect a company but are outside its control, such as a sudden strengthening of the rupee that might affect exports, having adverse effect on an export-oriented company’s stock.
Fundamental research before equity investment
You should be aware of the company in which you are investing. Some basic ratio like PE and EPS should be known.
You must have a clear idea of the shares you want to purchase, based on your investment objective, risk appetite, and the fundamental parameters of the share (stock). Some fundamental parameters are the earning per share (EPS) and the price to earning-per-share ratio (PE). The EPS is found by dividing the profit after tax by the outstanding number of shares in the market. Basically, do not just rely on recommendations received from your broker, friend, lover or anyone else. You can use these as a starting point, but ensure that you do your own independent bit of digging before you invest.
Another tip is if you feel a stock price is high, do not buy it. Only buy stocks that have scope for appreciation.
Yet another tip do not try to time purchases, as a matter of course. While seismic upheavals in the stock market will give you obvious signs to either buy or sell, do not rely only on timing the markets. This will turn you into a speculator rather than an investor.
And lastly, if your research shows that the prospects of the company you own stock in do not look rosy in the long term, get rid of the stock. Do not hesitate to liquidate your portfolio even before your targeted time horizon if you think that it isn’t worth it. In the end, it is your money, and above all, you must be comfortable in keeping it invested.