6 Equity Investments - 6. Equity Investments - 6. Equity Investments Explained

Key Concepts

• Common Stock
• Preferred Stock
• Dividends
• Stock Valuation
• Equity Market Indices

Common Stock

Common Stock represents ownership in a company and carries voting rights. Holders of common stock are entitled to share in the company's profits through dividends and capital appreciation. However, they are the last in line for asset distribution if the company goes bankrupt.

Example: If you own common stock in a company, you have the right to vote on important company decisions, such as the election of board members, and you may receive dividends if the company decides to distribute profits.

Preferred Stock

Preferred Stock is a hybrid security that combines features of both equity and debt. Preferred shareholders receive dividends before common shareholders and have priority in asset distribution if the company liquidates. However, they typically do not have voting rights.

Example: A company issues preferred stock with a fixed dividend rate of 5%. Preferred shareholders receive this dividend before any dividends are paid to common shareholders, ensuring a steady income stream.

Dividends

Dividends are payments made by a company to its shareholders, usually from its profits. Dividends can be in the form of cash, additional shares of stock, or other assets. The decision to pay dividends is made by the company's board of directors.

Example: A company announces a quarterly dividend of $0.50 per share. If you own 100 shares, you will receive a payment of $50. This payment can be reinvested or used as income.

Stock Valuation

Stock Valuation involves determining the intrinsic value of a stock. Common methods include Discounted Cash Flow (DCF) analysis, Price-to-Earnings (P/E) ratio, and Dividend Discount Model (DDM). Valuation helps investors make informed decisions about buying or selling stocks.

Example: Using the DCF method, you forecast a company's future cash flows and discount them to their present value. If the present value is higher than the current stock price, the stock may be undervalued and worth purchasing.

Equity Market Indices

Equity Market Indices are statistical measures representing the performance of a specific segment of the stock market. They are used to track market trends, compare performance, and as benchmarks for investment portfolios. Examples include the S&P 500 and the NASDAQ Composite.

Example: The S&P 500 index tracks the performance of 500 large-cap U.S. companies. If the index rises by 2%, it indicates that the average stock price of the companies included in the index has increased by 2%.