Business | Markets
What it means to invest in equities
Carefully putting money in the right shares can help people multiply their wealth.
- By Arindam Banerjee, Special to Gulf News
- Published: 23:25 July 3, 2009
- Image Credit:
The past year has not been easy for the average investor. Capital markets plunged to all time lows, fundamentally healthy stocks (stocks of companies having sound financial health and good business prospects) lost a significant portion of their value, mainly driven by erosion of investor confidence and triggered by negative market sentiments.
The regional markets too experienced a similar fate. The Dubai Financial Market (DFM) that once rose to a high of over 8,000 points, has now dropped to around 1,600 points, and has been around this level for a few months.
Investors started focusing more on preserving their wealth rather than making more out of it. Simply put, investors did not want to lose any more of their hard-earned money in an attempt to make more.
But one cannot remain passive for long and markets do not stagnate at their bottoms. Holding cash yields almost nothing after adjusting for inflation. And moreover, one needs to invest for the future and that is where capital markets, more specifically, the equity markets play a crucial role. But why buy equities?
Equity, shares, or stock, all means the same thing. Equity represents a share in the ownership of a company. It represents a claim on the company's assets and earnings. The ownership stake in the company increases as one acquires more equity.
So next time when you buy a share of Air Arabia or Gulf Navigation, for instance, you become a proud owner of the company (to the extent of your ownership).
This ownership entitles you to the profits of the company in the form of dividends and other benefits. Thus, when you invest in equity, you are actually investing in the business of the company and letting your investment reap benefits from the investments made. It really sounds exciting. Yes it does, but there are certain important elements to keep in mind.
We are all aware that there isn't any free lunch, at least in the investment world and equity investments do come with certain degree of risks.
So, before investing in equity, investors need to check their risk profile. In simple words, you have to answer a simple question, are you meant for equity investments? If age is on your side and you are capable of taking risk and more importantly tolerating it, the world of equities beckons you.
The next important thing is to decide how much to invest in equities. The rule of thumb is, "Hundred minus Age", so if you are 30, you need to put 70 per cent of your total investments (investment portfolio) in equities and vice versa.
The rationale behind this is simple, young age comes with more risk seeking abilities as well as more risk tolerance level, and moreover it provides many more years to recover your fallen fortunes in case the markets behaved opposite to your expectations.
Another aspect of equity investments is the way one finances it. No matter how exciting and buoyant the stock market is, you should never stretch borrowings to invest in this asset class. Investments in shares are in essence investments in business of the company and companies provide sustained returns only in the long run. So, shares are long-term investments that should never be financed by short-term borrowings.
The trick is to analyse stocks for the long term by way of fundamental analysis. Companies with healthy cash flows, sustained earnings, good business prospects, growth potential, sound corporate governance and enjoying investor confidence are the one to look out for.
There are various ways to analyse such companies, the popular among them are analysing some of the key ratios of the company. These ratios are readily available in the respective stock exchange websites (DFM, ADSM, etc.) and several stock brokers. Fundamental analysis avoids market timings and focuses more on investment discipline. So, next time you go for equity investments, spend some time flipping through the annual reports of your target company.
The other way to analyse stocks is reading the charts and graphs, more commonly known as technical analysis. This approach is more directed towards understanding the short-term trend movements that are not fundamental in nature. They are the favourite tools for traders and speculators.
Banerjee is a finance and accounting professor at S.P. Jain Center of Management Dubai and Singapore.
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