Equity Securities
Core features
Equity represents an ownership claim: residual earnings after all obligations, voting rights at general meetings, and a claim on liquidation proceeds that ranks last. Candidates must know common (ordinary) shares versus preference shares (fixed dividend, priority over common, often non-voting, sometimes cumulative or participating). Understand authorised, issued and outstanding share counts, and treasury shares.
Returns and valuation
Total return = price change plus dividends. Know dividend mechanics: declaration, ex-dividend and payment dates, and that buying on or after the ex-date forfeits the declared dividend. Be comfortable with the dividend discount model (P = D1 / (r − g)) and the price-earnings ratio as a relative valuation shortcut.
Corporate actions
Rights issues (existing holders get pre-emption), stock splits (more shares, lower price, no change in value), bonus issues, share buybacks (reduce shares outstanding, can lift EPS), and mergers. Traps: confusing a split with a bonus issue, or forgetting that a rights issue is priced at a discount and dilutes non-participants.
Risk and classification
Equity ranks behind debt in the capital structure, so it carries greater risk but uncapped upside. Classify by size (large/mid/small cap), style (value, growth, blend), sector and geography. Know cumulative preference dividends accrue if skipped, while non-cumulative do not.
Worked example
A stock pays a dividend of 2.00 next year, required return 10%, growth 4%. Value = 2.00 / (0.10 − 0.04) = 33.33. If it trades at 40, it looks expensive on this model. Note the sensitivity trap: if g approaches r, the model explodes - a classic distractor.
Rule of thumb
Equity is last in line for cash and first in line for upside; preference shares sit between debt and common.