All about assets: equities

Will Hodges looks at shares – which play a hugely significant part in the investment world

What are equities?

Equities, better known as stocks or shares, are one of the oldest forms of financial asset. An equity investment involves the purchase of a share of a company which can range from a tiny fraction to 100 per cent of it. In return, the company receives a cash advance from the person buying the stake, which it can use to buy new raw materials, expand, or pay its creditors.

The company may be private, meaning the share are bought directly from the owner of the company with his or her agreement, or public, in which case the shares are bought and sold via a stock market such as the FTSE.

What's all the fuss about?

Equities have long been considered one of the most profitable forms of financial investing and, despite the emergence of many newer asset classes, remain the largest single component of global investment portfolios. To put it into perspective, the global stock market was valued at an astonishing $54.8 trillion (around £34.8 trillion) as of 2010 (World Federation of Exchanges). Returns from equity investing have consistently outperformed their biggest rival asset class, bonds, with the average annual rate of return on the world's largest stock market (the US S&P 500) estimated at 7.5 per cent in the 60 years to January 2012.

Who invests in equities?

Shareholders come in all shapes and sizes. Investors in a listed blue chip company like Tesco, for example, are likely to range from multinational investment firms with many millions invested, to retirees possessing just a handful of shares, and everything in between. While the value of two different holdings may vary greatly, they are usually subject to the same rights, the same rate of return on their investment and, of course, the same risk of financial loss.

What are the advantages of investing in equities?

The beauty of equity investment is that what you see is what you get. If a company does well, makes profits and increases in value, as an investor you are entitled to a share of its increased worth. If it drops in value, you are obliged to shoulder a proportion of this loss. It's that simple. Overall, however, returns have traditionally been high. If an investor were to have bought a share in every company in the FTSE 100 index in 1985, his or her investment would have grown by an average or 11.3 per cent a year by the end of 2011. Compare this with the 3-4 per cent you would receive from leaving your investment in a no-frills savings account (in a good year) and the advantages become clear.

Besides seeing the value of their investment increase, shareholders of many companies receive an added bonus in the form of dividend pay-outs. A dividend is a share of the company's earnings which is paid in the form of a one-off payment at certain times during the year.

What are the disadvantages of investing in equities?

As is the general pattern with financial investment, with great reward comes great risk. The biggest threat for equity investors has always been volatility. They must be willing to accept huge swings in value. For all its growth over the past 25 years, the FTSE 100 has been known to see its value drop by as much as 30 per cent in a single year (as it did in 2008). Investors playing the long game must accept the bumps in the road, while short-term investors will hope to be shrewd enough to side-step these losses. Doing so is easier said than done, however, as the behaviour of equity investments is at best unpredictable and at worst a mystery. Stock markets react irrationally to economic, financial or political news and even the most savvy of stock-market players will admit to having been badly burned on more than one occasion.

In the worst case scenario, equity investors must be prepared to write off completely the money they've invested in a particular company. If it goes into liquidation, its creditors (those holding debt contracts with the company) are first in line to repaid. Equity investors must wait until the carcass has been picked over by them before staking a claim for whatever's left.

Where could I fit in?

With London increasingly recognised as the world's leading financial centre, the world of equity investment offers no end of opportunity for UK graduates. Here are just some of the possibilities:

  • Equities analyst at an investment bank or investment firm
  • Equities trader at an investment bank, brokerage firm or hedge fund
  • Equity salesperson at an investment bank or brokerage
  • M&A analyst at a bank or consultancy firm
  • Equities analyst at a financial research firm