Equity investment

Equity investment generally refers to the buying and holding of shares of stock on a stock market by individuals and funds in anticipation of income from dividends and capital gain as the value of the stock rises. It also sometimes refers to the acquisition of equity (ownership) participation in a private (unlisted) company or a startup (a company being created or newly created). When the investment is in infant companies, it is referred to as venture capital investing and is generally understood to be higher risk than investment in listed going-concern situations.

Table of contents
1 Direct holdings and Pooled funds
2 Fundamental Analysis and Technical Analysis
3 How share prices are determined
4 Related Material
5 Further Reading

Direct holdings and Pooled funds

The equities held by private individuals are often held via mutual funds or other forms of pooled investment vehicle, many of which have quoted prices that are listed in financial newpapers or magazines; the mutual funds are typically managed by prominent fund management firms (e.g. Fidelity or Vanguard). Such holdings allow individual investors to obtain the diversification of the fund(s) and to obtain the skill of the professional fund managers in charge of the fund(s). An alternative usually employed by large private investors and institutions (e.g. large pension funds) is to hold shares directly;in the institutional environment many clients that own portfolios have what are called segregated funds as opposed to, or in addition to, the pooled e.g. mutual fund alternative.

The Pros and Cons of holding shares directly or via pooled vehicles

The major advantages of investing in pooled funds are access to professional investor skills and obtaining the diversification of the holdings within the fund. The investor also receives the services associated with the fund e.g. regular written reports and dividend payments (where applicable). The major disadvantages of investing in pooled funds are the fees payable to the managers of the fund (usually payable on entry and annually and sometimes on exit) and the diversification of the fund that may or may not be appropriate given the investors circumstances.

It is possible to over-diversify. If an investor holds several funds, then the risks and structure of his overall position is an amalgam of the holdings in all the different funds and arguably the investors holdings successively approximate to an index or market risk.

The costs or fees paid to the professional fund management organisation need to monitored carefully. In the worst cases the costs (e.g. fees and other costs that may be less obvious hidden fees within the workings of the investing organisation) are large relative to the dividend income payable on the stock market and to the total post-tax return that the investor can anticipate in an average year.

Fundamental Analysis and Technical Analysis

To try to identify good shares to invest in, two main schools of thought exist: technical analysis and fundamental analysis. The former involves the study of the price history of a share(s) and the price history of the stock market as a whole; technical analysts have developed an array of indicators, some very complex, that seek to tease useful information from the price and volume series. Fundamental analysis involves study of all pertinent information relevant to the share and market in question in an attempt to forecast future business and financial developments including the likely trajectory of the share price(s) itself. The fundamental information studied will include the annual report and accounts, industry data (such as sales and order trends) and study of the financial and economic environment (e.g. the trend of interest rates).

How share prices are determined

The dominant theory about equity price determination in professional investment circles continues to be the Efficient Markets Hypothesis (EFM). Briefly, this theory suggests that the share prices of equities are priced efficiently and will tend to follow a random walk determined by the emergence of news (randomly) over time. Professional equity investors therefore tend to spend their time immersed in the flow of fundamental information seeking to gain an advantage over their competitors (mainly other professional investors) by more intelligently interpreting the emerging flow of information (news).

The EFM theory does not seem to give a complete description of the process of equity price determination, for example because share markets are more volatile than a theory that assumes that prices are the result of discounting expected future cash flows would imply. In recent years it has come to be accepted that the share markets are not perfectly efficient, perhaps especially in emerging markets or other markets where the degree of professional (very well informed) activity is lacking.

Related Material

Further Reading

  • Chapter 12 of The General Theory of Employment Interest and Money, by John Maynard Keynes (Author), 1936.
  • Yes, You Can Time the Market!, by Ben Stein (Author), Phil DeMuth (Author), John Wiley & Sons, 2003, hardcover, 240 pages, ISBN 0471430161
  • The Profit Magic of Stock Transaction Timing, J.M.Hurst (Author), Prentice-Hall, 1970.
  • Security Analysis: Principles and Techniques (Second Edition), Benjamin Graham and David Dodd (Authors); (a classis study of how to analyse companies prior to investment).



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