By Colombo Stock Exchange 

As you advance in your investment journey, understanding the core components of equity investment is crucial. Building on the foundational concepts covered in column two last week, this instalment explores why shares are a strong investment, difference between equity and debt capital and what going public entails.

Why shares specifically?

Shares, also known as stocks, represent ownership in a company and offer potential for long-term capital growth. Though they may offer higher returns compared to bonds or savings accounts, they also carry higher risks. Investing in shares can potentially provide both capital appreciation and dividends but it’s important to weigh these opportunities against the inherent market risks.

Shares are particularly appealing because they offer the opportunity to participate in the success of a company. As companies grow and generate profits, the shareholders can benefit through an increase in the value of their shares and dividend payments. Despite the inherent risks—such as market volatility—shares provide a means to potentially surpass inflation and achieve substantial returns.

Equity capital and debt capital

Companies have two primary methods to raise capital: equity and debt.

• Equity capital: Raised by issuing shares, equity capital represents company ownership. The shareholders receive profits and may have voting rights but bear the risk of fluctuating company performance. Unlike debt, equity doesn’t need repayment.
• Debt capital: Borrowed from external sources like banks or through debentures, debt capital must be repaid with interest. Debt investors don’t gain ownership but receive regular interest and principal repayment. It generally carries lower risk but offers lower returns compared to equity.

What are listed companies and what does ‘going public’ mean?

When a company ‘goes public’, it means it has listed its shares on a stock exchange, making them available for trading. This process involves complying with the exchange’s regulations and disclosing financial information to the potential investors. The listed companies must meet specific criteria such as having a certain number of shareholders and demonstrating financial stability, to maintain their listing status.

Why do investors buy shares?

Investors buy shares for many reasons, aiming to grow wealth and manage risk effectively.

• Diversification: Investors use shares to diversify their portfolios and spread risk, minimising the impact of poor performance in any investment.
• Capital growth: Shares offer potential for capital growth as prices increase over time, historically providing higher returns than other options.
• Dividends: Shares can provide regular income through dividends from a company’s profits, varying with the company’s financial performance.
• Liquidity: Shares are liquid assets, easily bought or sold in the market, offering financial flexibility and quick conversion to cash.

Understanding these concepts equips you to make informed investment decisions. However, before making any investment decisions, it is crucial to consult with a stockbroker. Stay tuned for our next article, where we will further explore how to evaluate and choose the right investment strategies.