Equities - Back to Basics

Issue Date: 2010-01-22

Eric Elbers

“Equities,” “stocks,” and “shares” are three words that often mean the same
thing. If you invest in an equity mutual fund, you indirectly own common
stocks or shares. Common shareholders are the owners of a public company
and provide the equity capital to carry on or expand the business. If the
business prospers, common shareholders may receive dividends, or make
capital gains if their shares are sold at a profit. If the business fails, common
shareholders may lose their entire investment.
The rights and advantages of common share ownership are as follows:
Potential for capital appreciation
The right to receive any common share dividends paid by the company
Voting privileges
Favourable tax treatment of dividend income and capital gains
Marketability – share holdings can be increased or decreased
Capital appreciation can derive from an increase in the share price or from
stock splits. The price of shares follows the law of supply and demand - if
many people want to buy a stock, the price goes up. Demand is usually based
on the value that people see in the company issuing the shares. This can be
present value (in the case of a highly profitable company) or future value (in
the case of a company with small current profits but a bright future).
Because most companies prefer to keep their share price in a popular range
from $10 to $100, a stock split may be used to bring a high-priced stock back
into this range. If you own 50 shares of a $100 stock and it splits two-forone,
you will own 100 shares of a $50 stock. If it splits four-for-one, you will
own 200 shares of a $25 stock. The total value is unchanged, just divided
among more shares.
Common stock dividends may be paid by a company if there are profits left
after paying expenses, bond interest, debenture interest and preferred
dividends. The board of directors determines the dividend policy, and
mature companies may pay dividends while growing companies may retain
their earnings to fund future growth. Some companies designate a specific
dividend that will be paid each year, while others prefer to retain dividend
flexibility.
Dividends are included in determining the annual yield for a common
stock, with regular dividends usually increasing the demand for the stock
and the stock price.
Some companies offer a dividend reinvestment plan whereby declared
dividends are automatically used to purchase additional stock for its
shareholders.
The dividends received from common share ownership have preferential
tax treatment over the interest received from corporate bonds. This is to
avoid double taxation since interest payments on bonds, but not dividend
payments on stocks, are tax-deductible by the company. If you sell stocks, or
shares in equity mutual funds, at a profit, you will earn capital gains, which
also have preferential tax treatment over interest income.