CA Shefali Mundra
The Indian financial market has been an abode for a diversified range of investment options catering to different categories of investors. Equity investment is one of the most effective investment options for risk-friendly, aggressive, knowledgeable investors. It is a high-risk option with the potential to generate higher returns adding significant value to an investor's portfolio.
An investor with a high-risk appetite can choose to invest in equities differently. Firstly, through Direct Equity, and secondly, through mutual funds. Well, both direct equity and mutual funds are ideal long-term investment options, but the capability to understand equities can make direct equity more rewarding than mutual funds.
Over the years, returns on direct equity have significantly outperformed other asset classes. However, one should be able to decode the actual value of stocks by analyzing the underlying business and the company's records, reviewing financial performance, and other relevant external factors.
Investors can draw inferences from a simple example. 'Direct equity investment' is almost similar to like buying clothes from a factory directly. It takes time and effort, but you make the right choice and save money by eliminating intermediaries.
1. Complete Control Over Investments.
By investing directly in stocks, investors get a chance to gain legal ownership with voting rights in the company. Additionally, direct participation in the stock markets entitles an investor to earn returns from corporate actions such as dividends, bonus, rights issue, buyback, stock splits, and income from the sale of stocks. Direct equity investment is an ideal option for investors aspiring to have complete control over their investments. Investing directly in stocks gives one complete authority to buy, hold, and sell at their convenience.
Alternatively, in the case of mutual funds, the fund manager holds complete control of investments and decides when to buy, hold or sell the stock.
2. Potential of Higher Returns.
Stock returns have significantly outperformed all the other investment options in the long and short term. For instance, let's consider reliance industries limited stock currently trading at ₹2600 and compare 1-year returns with an ICICI Prudential Bluechip Fund – Direct plan. It clearly shows that the direct stock investment into Reliance has resulted in a return of approximately 12%, which is higher than the annualized return of approximately 7% on investment through the ICICI Prudential Bluechip fund.
Direct equity investment can give good returns, but it calls for an effective and strategic approach to stock picking to get good returns with time. Understand fundamental analysis and make the right choice.
3. Dividend Income.
Perpetual investing in dividend-paying stocks enables an investor to reap the benefits of a consistent and steady source of income. Investment in companies with a tremendous profitable record and solid presence in the industry safeguards an investor against market volatility. Dividend investing is a great strategy to navigate successfully through market headwinds.
For instance, Coal India has a good dividend track record and announced an equity dividend of 170% in March 2022, amounting to ₹17 per share. Investing directly in dividend stocks unlocks the potential to earn passive income as long as the company has solid fundamentals and is profitable.
4. Tax Advantages.
Tax benefits on equity investments top the table. An investor holding equity shares make capital gains on the sale of shares. The rate of taxability is dependent upon the time invested in the stocks, and it is lower than the applicable slab tax rates. If an investor sells shares listed on a recognized stock exchange within one year of the purchase, then it is a short-term capital gain taxable at 15% (plus surcharge and cess applicable). Alternatively, a long-term capital gain (LTCG) is taxable at 10%(plus surcharge and cess applicable) without indexation benefit if they sell equity shares after one year of purchase. Under the section 112A of the Income Tax Act, 1961, an investor gets an exemption of ₹1,00,000 on the sale of equity shares. Additionally, an investor can set off losses incurred within the capital gains head.
5. Bonus Shares.
Companies might utilize their accumulated earnings to issue bonus shares instead of dividends and encourage retail participation. Existing Shareholders get bonus shares without incurring an additional cost. They are issued in proportion to the investor's current shareholding; hence, it reduces the overall price of the share and increases the number of outstanding shares. Bonus shares are an attractive option for long-term investors aspiring to multiply their investments.
A higher number of shares increases the chances of making higher profits. For instance, REC Limited announced bonus in the ratio of 1:3. Following the announcement, REC's stock price jumped by 3%.
6. Right Shares.
Companies preferentially offer the right shares to existing shareholders, ensuring the preservation of ownership and at comparatively lower prices than the stocks' market price. Shareholders can either exercise the rights offered, refuse the offer or renounce the rights to someone else. Exercising the rights provides an opportunity to increase the stake in the company at a lower price or renounce rights at the market price and earn the difference.
Suzlon Energy Ltd, one of the top manufacturers operating in the wind component manufacturing segment, announced a rights issue in the ratio of 5:21. The rights issue was announced for ₹5(including premium ₹3) per equity share while it was trading at ₹8. If a shareholder had 10000 shares, they are entitled to a right of 2380 RE shares. The Suzlon Energy RE got listed at ₹2 per share. The shareholder can either renounce the rights and earn a profit of ₹2 or exercise the right to increase their stake in the company.
7. Buy Back of Shares.
Companies buy back shares to reinvest in the company, which indirectly increases the shareholder's value. The buyback scenario directly impacts the company's EPS (Earning per share) and increases the ratio. The net income remains the same, and the number of outstanding shares reduces, growing EPS. Additionally, shareholders can benefit from the buyback of equity shares as they majorly receive the capital amount at a premium.
As per section 115QA of the Income Tax Act, 1961, both listed and unlisted companies are liable to pay an additional tax of 20%(surcharge and cess applicable) on the distributed income(Buyback price-Issue price). Shareholders are not liable to pay tax.
8. Stock Splits.
Companies might introduce stock splits to make shares affordable for all and increase investor demand. Stock splits reduce the cost of investment, increasing the outstanding number of shares without adding any new value or diluting shareholders' stake. As the prices of stocks are inversely proportional to demand, the demand rises with a decrease in prices. Eventually, the increase in demand drives the stock price.
9. Collateral for Loans.
Financial emergencies or fund requirements to attain short-term or long-term goals can occur at any point in life. Getting loans from banks or other financial institutions is one ideal option to fulfill the financial requirement. In response to this, furnishing collateral such as real estate or other physical possessions against loans is risky. At this point, one can provide stock investments as collaterals and avail loan immediately. Most lending institutions allow loans up to 50% of the eligible equity shares owned by an investor.
In a nutshell, investing directly in stocks is beneficial and holds the potential to generate higher returns. However, one must be well-equipped and well-driven by facts and figures and control emotions. As there is a probability of higher risks in the case of investing directly in stocks, one must pick the right stocks with fundamental analysis, diversify investments and keep a constant check on the portfolio to keep track of the returns generated with time.
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