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Home > Glossary
> 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.
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 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.
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).
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.
- 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
- 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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