What are the Ordinary Shares or Equity Shares? Features, Benefits, Limitations, Rights, and Alternatives.
Ordinary shares, or equity shares, are the most common type of stock issued by a company. When you buy ordinary shares, you’re essentially purchasing a piece of ownership in the company. This ownership comes with certain rights and potential rewards, but also some risks.
In this article, we’ll explore the basic concept of ordinary shares and what it means to be a shareholder. We’ll cover:
Ownership Representation: Each ordinary share represents a fractional ownership stake in the company. The more shares you own, the larger your ownership percentage.
Shareholder Rights: Ordinary shareholders have the right to vote on important company matters, such as electing board members and approving major business decisions. This voting power allows you to have a say in the company’s direction.
What you are going to learn?
Rights and Privileges of Ordinary Shareholders
As we learned previously, ordinary shares come with ownership rights that give shareholders a stake in the company’s performance. Let’s explore these rights in more detail:
Voting Rights:
This is a key privilege of ordinary shareholders. The number of votes you have typically corresponds to the number of shares you own (one vote per share). You can exercise your voting rights at shareholder meetings to:
- Elect board members who oversee the company’s management.
- Approve major business decisions, such as mergers, acquisitions, or stock issuance.
- Vote on proposals presented by the company’s management.
Dividend Rights:
Ordinary shareholders are entitled to receive a portion of the company’s profits, called dividends. However, unlike preference shareholders (discussed later), dividends for ordinary shares are not guaranteed. The company’s board of directors decides whether or not to distribute dividends, and the amount paid out depends on the company’s profitability.
Capital Appreciation:
Owning ordinary shares also gives you the potential for capital appreciation. This means the value of your shares could increase over time as the company grows and becomes more profitable. You can then sell your shares at a higher price than you bought them for, generating a capital gain.
Preemptive Rights:
In some cases, ordinary shareholders may have preemptive rights. This gives them the first opportunity to purchase additional shares of the company’s stock when it’s issued, allowing them to maintain their ownership stake proportionally.
Risks and Drawbacks of Ordinary Shares
While ordinary shares offer the potential for high returns, they also come with inherent risks that investors should be aware of:
Share prices can fluctuate significantly based on various factors like company performance, industry trends, and overall market sentiment. This volatility means the value of your ordinary shares could decline, leading to capital losses if you sell them before the price recovers.
Company Risk:
The success of your investment is directly tied to the company’s performance. If the company experiences financial difficulties, mismanagement, or unforeseen events, the share price could plummet significantly. In the worst-case scenario, a company bankruptcy could result in a complete loss of your investment.
Limited Claim on Assets:
Ordinary shareholders rank last in line when it comes to claims on a company’s assets during liquidation. This means that bondholders, creditors, and even preferred shareholders will be paid out first if the company goes bankrupt. Ordinary shareholders may receive little or nothing.
Dividend Uncertainty:
Unlike preferred shares, dividends for ordinary shares are not guaranteed. The company’s board has the discretion to decide whether or not to distribute dividends, and the amount paid can vary depending on profitability.
Lack of Control:
As a small shareholder, you likely won’t have a significant influence on the company’s decisions. Voting power is usually concentrated with large institutional investors who hold a majority of shares.
Beyond Ordinary Shares: Exploring Alternative Options
While ordinary shares are the most common, companies can issue other types of shares with different rights and privileges. Here’s a look at some alternatives:
These shares offer certain preferences over ordinary shares, typically regarding dividends. Preference shareholders usually receive a fixed dividend payout before any dividends are distributed to ordinary shareholders. However, they often have limited or no voting rights.
Dual Class Shares:
Some companies issue different classes of ordinary shares with unequal voting rights. For example, Class A shares might have one vote per share, while Class B shares (often held by founders or controlling entities) might have multiple votes per share, giving them greater control over company decisions.
Restricted Shares:
These shares come with limitations on when and how they can be traded. They are often issued to employees or as part of a financing agreement. Restricted shares may vest over time, meaning the shareholder only gains full ownership rights after meeting certain conditions.
Treasury Shares:
These are shares that a company has repurchased from the market. Treasury shares are not outstanding shares and do not hold voting rights. Companies can use treasury shares for various purposes, such as employee stock options or future acquisitions.
Choosing the Right Shares: Ordinary vs. Alternatives
Now that you understand ordinary shares and some alternative options, let’s explore how they compare to help you make informed investment decisions:
Ordinary Shares vs. Preference Shares:
- Focus: Ordinary shares prioritize capital appreciation and potential for higher returns, while preference shares prioritize fixed income through dividends.
- Risk: Ordinary shares are riskier due to variable dividends and market volatility. Preference shares offer more predictable income but have lower growth potential.
- Control: Ordinary shares offer voting rights, allowing you to influence company decisions. Preference shares typically have no or limited voting rights.
Ordinary Shares vs. Dual Class Shares:
- Control: Ordinary shares offer some voting power based on the number of shares owned. Dual class shares with lower voting rights can limit your influence compared to those with higher voting power.
- Growth Potential: Both share types offer capital appreciation potential. However, companies with dual class structures might prioritize decisions favoring controlling shareholders, potentially impacting overall growth.
Ordinary Shares vs. Restricted Shares:
- Liquidity: Ordinary shares are freely tradable on stock exchanges. Restricted shares have limitations on trading, reducing their liquidity and potentially impacting your ability to sell them quickly.
- Investment Horizon: Ordinary shares are suitable for long-term investors comfortable with market fluctuations. Restricted shares might be appropriate if they align with your long-term investment goals and eventual vesting provides future liquidity.
Ordinary Shares vs. Treasury Shares:
- Ownership Rights: Ordinary shares represent ownership with voting and dividend rights (if declared). Treasury shares are not outstanding and do not hold these rights.
- Investment Opportunity: Ordinary shares offer the potential for capital appreciation and dividends. Treasury shares are not directly available for investment by the public.
Conclusion: Ordinary Shares – A Cornerstone of Equity Investing
Ordinary shares, also known as equity shares, form the foundation of stock market participation. They offer a unique blend of ownership rights, potential for capital appreciation, and dividend income (if distributed). However, they also come with inherent risks associated with market volatility and company performance.
Understanding the rights and drawbacks of ordinary shares is crucial for making informed investment decisions. By comparing them to alternative share types like preference shares and considering factors like your risk tolerance and investment goals, you can choose the investment vehicles that best suit your financial strategy.
Key Takeaways:
- Ordinary shares represent ownership in a company, granting voting rights and potential dividend payouts.
- Capital appreciation is a key driver of returns for ordinary shares, but market volatility can lead to price fluctuations.
- Compared to preference shares, ordinary shares offer higher growth potential but carry more risk due to variable dividends.
- Restricted shares and treasury shares have limitations on ownership and trading, making them less suitable for traditional investment strategies.
Remember, investing in ordinary shares requires careful research and a well-defined investment plan. By understanding the risks and rewards, you can leverage ordinary shares to participate in the growth potential of the stock market and achieve your long-term financial goals.
