The Distinction Between Equity and Stocks: A Subtle Overview

  • Written Written by Ali Nasir Kidwai 22 November 2023 | 4 min read
  • Editor's Note :

    This blog explores the disparity between equity and stocks, shedding light on their distinctions. Gain a clear understanding of these financial terms to make informed investment decisions.

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Introduction

As you kick off your day, the news is discussing equities and stocks, terms that might sound familiar, but have you ever delved into their precise definitions?

Although investors often use the two terms interchangeably, they aren't always the same. For example, stocks are typically publicly traded, while equities may not always follow this pattern. Nonetheless, both terms share the commonality of representing ownership in a company.

In this blog, we break down the similarities and differences between equities and stocks to understand their potential placement in your portfolio and make informed and impactful investment decisions.

Let’s Unlock the Hidden Difference: Equity vs. Stocks

stocks vs equity

Source:Google

Have you ever pondered the distinction between Equity and stocks? Let's begin by examining a company's balance sheet. When we refer to shareholder equity, what exactly does it entail? Shareholder equity comprises the share capital, the free reserves generated from profits, and the share premium account. Simply put, shareholder equity is everything to which each shareholder has a proportionate claim. The shareholder has a claim to the capital provided and to the profits plowed back, as well as to any premium collected on the issue of shares. These things are put together to represent the Equity. Equity is there for every company limited by shares, whether it is a private limited company or public limited company (unlisted company or listed company)

Understanding Fair Market Value for ESOPs

In this blog, we delve into the intricacies of understanding Fair Market Value (FMV) within the context of Employee Stock Ownership Plans (ESOPs).

When discussing stocks, our focus is solely on those officially listed and actively traded on a recognized stock exchange. Consequently, the fundamental distinction between stocks and equity stems from the listing of shares. It's crucial to remember that every stock possesses both a face value and a market value. The disparity between the market value and the face value represents the market's assigned valuation for the stock. This market value is a function of the unrestricted reserves, part of Equity. Shareholder equity can be alternatively viewed as the residual net assets of the company, calculated by subtracting total outside liabilities from total assets. That is Equity.

The notion of stocks comes into play when a portion of the company's ownership, also referred to as equity, is made available to the general public shareholders. Equity essentially represents the ownership stake in the company and encompasses the capital and value contributed by the promoters to the business. The Equity becomes a stock only when these shares are listed and routinely traded on the stock exchanges. Once the stock is listed, it can be freely traded like any other market-linked asset at the prevailing market prices. Equity per se cannot be traded, but stocks can be traded. The promoter never offers the full equity, which represents the net value of the business. He only shows a part of the Equity as Stock. However, the market price of the Stock typically represents the proportionate value of the company. In short, Equity represents the capital infused by a company's promoter, which, in exchange, grants them ownership of the company. At the same time, stocks are equity shares issued to the public to raise capital in return for ownership shares in the company.

Equity vs. Stock from a Practical POV

We know that Equity is the share capital + premium + free reserves in the balance sheet of the organization, which is also the net assets of the company. That raises the question of the value of such Equity, which is the same as the value of the Stock. A more effective gauge of a stock's worth lies in its market capitalization. For instance, when a company has one crore shares outstanding, and its market price is Rs180, then the market value is Rs180 crore. This represents the overall stock value. Although the market value serves as a reasonable estimate of worth, there's another valuation method employed in Mergers and Acquisitions (M&A) known as business value.

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The market value of Equity represents the true worth of a business, encompassing the combined value of the company's net assets, the present value of anticipated future cash flows, and the significance of any intangible assets such as brands, copyrights, patents, and other intangibles. This is essentially what the market price aims to encapsulate. That is why you find that the market price is usually a good approximation of business value, so the market value of Equity tends to converge towards the market value of the Stock. The balance sheet of the company reflects the book value of Equity, while the stock markets display the market value of the Stock. That should clarify the difference.

Now that we have understood the difference between these two terms. Let's wrap up this blog with this table that offers a comprehensive comparison between stocks and Equity, highlighting key differences in ownership, characteristics, and investment attributes.

Aspect
Stocks
Equity
Definition
A stock represents ownership in a company.
Equity is the value of an owner's interest in an asset, which can include stocks in a company.
Types
of Common stock and preferred stock.
Common equity and preferred equity.
Ownership
Stockholders are owners of the company.
Equity holders have an ownership stake in various assets, which can include stocks, real estate, or other investments.
Claim on Profits
Stockholders are entitled to a share of the company's profits in the form of dividends if declared.
Equity holders may receive profits or income from various sources, including investments in stocks, bonds, or real estate.
Voting Rights
Common stockholders typically have voting rights in corporate decisions. Preferred stockholders usually do not have voting rights.
Equity holders may or may not have voting rights depending on the type of investment or asset.
Risk and Returns
Stocks can offer potentially high returns but come with higher risk due to market fluctuations.
Equity investments vary in risk and return, depending on the asset type; stocks can be one component of an equity portfolio.
Liquidity
Stocks are generally more liquid as they can be bought and sold on stock exchanges.
Equity in the form of real estate or private investments may have lower liquidity and may take longer to convert to cash.
Market Regulation
Stock markets are regulated by government authorities to ensure fair trading practices.
Equity investments in private companies may have less regulatory oversight.
Valuation
Stocks are valued based on market demand, company performance, and other factors.
Equity investments may be valued based on market prices, appraisals, or financial performance of the underlying assets.
Transferability 
Stocks can be easily transferred between investors.
Some equity investments, like real estate, may require more complex legal processes to transfer ownership.
Dividend Payments
Stocks may pay dividends to common stockholders, but it's not guaranteed. Preferred stockholders often receive fixed dividends.
Equity investments like real estate may generate rental income, while dividends from stocks depend on the company's policy.
Investment Horizon
Stocks are suitable for both short-term and long-term investors.
Equity investments can have varying investment horizons, depending on the asset type. Real estate, for example, is often a long-term investment.

Final Thoughts

Henceforth, while stocks and Equity are often used interchangeably, they represent distinct concepts with unique characteristics and considerations. Stocks represent a direct ownership interest in a company and are highly liquid, subject to market regulations, and may provide capital gains and dividends. Equity, on the other hand, is a broader term that includes various ownership structures, offering different levels of liquidity, regulatory oversight, and potential returns.

When deciding between stocks and Equity, it's crucial to consider your investment goals, risk tolerance, and the specific attributes of the investment opportunity. Both options can be valuable components of a diversified portfolio, and understanding their differences will help you make informed investment decisions that align with your financial objectives. As a standard practice, it is highly recommended to seek guidance from a financial advisor or conduct comprehensive research before making any investment choices. For more information, you can contact us at Vega Equity !

About Vega Equity

Vega Equity offers companies an effective, intuitive, and paperless platform for managing equity. It provides accurate cap table management, customized user experiences, and precise information. Additionally, it assists in measuring KPIs, analyzing data, and tracking performance towards goals.

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