One, who holds an equity or equity share of a company, is actually a shareholder of that company. Small or large– whatever may be his equity holding, he shares responsibility of both good and bad of the company.
The percentage of profit, he is entitled to, depends on the degree of amount of his shareholding or equity holding in the company. The company can share its profit with the equity holder in two ways-either paying dividend or keeping it as “reserve” on its balance sheet.
Now the point is, how does an ordinary share holder stand to gain, if his share of profit is kept as ‘reserve’ on the balance sheet? In capital market parlance, it is called ‘Capital Appreciation’. The amount is kept and maintained in the company’s books, which is known as ‘Book Value’ of the company. As long as the investor holds his equity in the company, the amount belongs to him. If the company is wound up tomorrow, he will get that amount.
He cannot claim that amount as long as the company is alive and running. But it has a direct impact on the share value of the company in the stock market (capital market). This means he can gain out of ‘Capital Appreciation’ by selling his shares in the market.
When a company issues fresh shares in the market, the valuation is done by adding up its capital and its reserve surplus. When someone buys shares of a company, he makes proper due diligence of the company and its balance sheet. In that case also, all estimations are made looking at the company’s profit and loss, reserve and expenses. The larger the profit of a company, the higher the demand of its shares. Market value is determined by demand-supply interplay. This is called share valuation.
These are when the company makes a profit. But what if the company suffers a loss? An equity holder or shareholder is supposed to share both profit and loss of the company. Every year, at the annual general meeting of the company, all shareholders collectively decide on who will manage the company. Therefore, whoever has voting rights during the annual general meeting (AGM), are equally responsible for all activities (deeds) of the management committee. So a shareholder cannot wash his hands off when the company suffers a loss. The loss is also proportionately shared among the shareholders, and accordingly it gets deducted from the “reserve” amount, where the share of profit is kept. The valuation of share also changes accordingly, leaving a direct impact on the market value of the share.
Therefore, an investor must keep himself posted about all activities of the company and the developments on a regular basis if he has to buy shares of a company. Otherwise, some day his profit may be skyrocketing without his knowledge and someday it may vanish in the thin air just like that. That’s why it is said that there are risks in investing in shares. And who doesn’t know that return is directly proportionate to risks? The higher the risk, the larger would be profit or loss. Stock markets draw investing community all over the world. It therefore goes without saying that one who keeps himself more informed, stands greater chance of doing away with losses and making profit.
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– Ritwick Mukherjee