TYPES OF SHARES :-
The capital of a company can be divided into different units with definite value called shares. Holders of these shares are called shareholders or members of the company. The Indian Companies Act prescribes that a public Ltd company can issue only 2 classes of shares :-
(a) Equity or Common shares or stocks
(b) Preference shares or stocks
(A) COMMON SHARES AS OWNERSHIP SHARES :-
Common stocks also known as Equity securities or Equities, represent ownership shares in a corporation. Each share of common stock entitles its owner to one vote on any matters of corporate governance that are put to a vote at the corporations Annual meeting and to a share in the financial benefits of ownership. ( A corporation sometimes issue two classes of common stock, one bearing the right to vote, the other not. Because of its restricted rights, the non-voting stock might sell for a lower price )
Holders of common stock exercise control by electing a board of directors and voting on corporate policy. Common stockholders are on the bottom of the priority ladder for ownership structure.
Equity shares will get dividend and repayment of capital after meeting the claims of preference shareholders. There will be no fixed rate of dividend to be paid to the equity shareholders and this rate may vary from year to year.
This rate of dividend is determined by directors and in case of larger profits, it may even be more than the rate attached to preference shares. Such shareholders may go without any dividend if no profit is made.
In the event of liquidation, common shareholders have rights to a company's assets only after bondholders, preferred shareholders and other debt holders have been paid in full.
If the company goes bankrupt, the common stockholders will not receive their money until the creditors and preferred shareholders have received their respective share of the leftover assets.
This makes common stock riskier than debt or preferred shares. The upside to common shares is that they usually outperform bonds and preferred shares in the long run.
Either it may be in the secondary market, ( previously functioning shares ) or a new issue such as ( IPO, FPO, ) Initial public offer, Follow on Public Offer, etc. The number of Share holders may be varying daily., for a Specified Stock. The same condition for Other Stocks Also.
The common stock of most large corporations can be bought or sold freely on one or more stock Exchanges.
CHARACTERISTICS OF COMMON STOCK :-
The two most important characteristics of common stock as an investment are its residual claim and Limited Liability features :-
1) Residual claim means that stock holder are the last in line of all these who have a claim on the Assets and income of the Corporation. In a liquidation of the firm’s assets the shareholders have a claim to what is left after all other claimants such as the Tax activities, Employees, Suppliers, Bondholders, and other creditors have been paid. For a firm not in liquidation, shareholders have claim to the part of operating income left over after interest and taxes have been paid. Management can either pay this residual as cash dividends to shareholders or re-invest it in the business to increase the value of the shares.
2 ) Limited Liability means that the most shareholders can lose in the event of failure of the corporation is their Original Investment. Unlike owners of Un- incorporated business , whose creditors can lay claim to the personal assets of the owner ( House, Car, Furniture ) corporate shareholders may at worst have worthless stock. They are not personally liable for the firm’s obligations.
(B) PREFERRED SHARES :-
Capital stock which provides a specific dividend that is paid before any dividends are paid to common stock holders, and which takes precedence over common stock in the event of a liquidation. Also unlike common stock, preference shares pay a fixed dividend that does not fluctuate, although the company does not have to pay this dividend if it lacks the financial ability to do so. The main benefit to owning preference shares are that the investor has a greater claim on the company's assets than common stockholders.
Like common stock, preference shares represent partial ownership in a company, although preferred stock shareholders do not enjoy any of the voting rights of common stockholders.
Preferred shareholders always receive their dividends first and, in the event the company goes bankrupt, preferred shareholders are paid off before common stockholders.
In general, there are four different types of preferred stock:
a) Cumulative preferred stock,
b) Non-cumulative preferred stock,
c) Participating preferred stock, and
d) Convertible preferred stock.
Preferred stock has features similar to both equity and debt. Like a bond it promises to pay its holder a fixed amount of income each year. Suppose profitable gains are obtained then a Higher rate of Dividend will be given for Equity share holders, whereas only a limited previously given dividend may be given.
In this sense preferred stock is similar to an Infinite-maturity bond that is a perpetuity. It also resembles a bond in that it does not convey voting power regarding the Management of the firm. Preferred stock is an equity investment however.
The firm retains discretion to make the dividend payments to the preferred stock holders. It has not contractual obligation to pay these dividends. Instead preferred dividends are usually cumulative. That is unpaid dividend cumulative and must be paid in full before any Dividend may be paid to holders of common stock.
In Contrast, the firm does have a contractual obligation to make the interest payments on the Debt. Failure to make these payments sets off Corporate Bankruptcy proceedings.
Preferred stock payments are treated as dividend rather than interest, they are not tax deductible expenses for the firm. This disadvantage is somewhat offset by the fact that corporations may exclude 70 % of dividends received from Domestic Corporations in the Computation of their taxable income. Preferred stocks therefore make desirable fixed income investments for some corporations.
Even though preferred stock ranks after bonds in terms of the priority of its claims to the Assets of the firm in the event of Corporate Bankruptcy, preferred stock often sells at lower yields than do Corporate Bonds.
Presumably this reflects the value of the dividend exclusion, because the higher risk of preferred would tend to result in higher yield than those offered by Bonds. Individual Investors, who cannot use the 70 % tax exclusion, generally will find preferred stock yields unattractive relative to these on other available assets.
Preferred stock is issued in variations similar to those of Corporate Bonds. It may be callable by the issuing firm, in which case it is said to be redeemable. Due to an uncertain condition if the company is under a loss, being de-listed, then first a major portion of assets belonging to the company, would be divided to the preference share holders and the debts may be cleared , later the balance amount if any may be divided for the common share holders. It also may be convertible into common stock at some specified conversion ratio. Adjustable rate preferred stock is another variation that, like Adjustable-rate bonds, ties the dividend to current market interest rates.
a) Cumulative Preference Share
If the company does no earn adequate profit in any year, dividends on preference shares may not be paid for that year. But if the preference shares are cumulative such unpaid dividends on these shares go on accumulating and become payable out of the profits of the company, in subsequent years.
Only after such arrears have been paid off, any dividend can be paid to the holder of Equity shares. Thus a cumulative preference shareholder is sure to receive dividend on his shares for all the years our of the earnings of the company.
If the dividend is not paid, it will accumulate for future payment.
b) Non-cumulative Preference Shares
The holders of non-cumulative preference shares no doubt will get a preferential right in getting a fixed dividend it is distributed to quality shareholders. The fixed dividend is to be paid only out of the divisible profits but if in a particular year there is no profit as to distribute it among the shareholders, the non-cumulative preference shareholders, will not get any dividend for that year and they cannot claim it in the next year during which period there might be profits.
If it is not paid, it cannot be carried forward. These shares will be treated on the same footing as other preference shareholders as regards payment of capital in concerned.
Dividend for this type of preferred stock will not accumulate if it is unpaid. Very common in TRuPS and bank preferred stock, since under BIS rules, preferred stock must be non-cumulative if it is to be included in Tier 1 capital.
c) Redeemable Preference Shares
Capital raised by issuing shares, is not to be repaid to the shareholders (except buy back of shares in certain conditions) but capital raised through the issue of redeemable preference shares is to be paid back by the raised thought the issue of redeemable preference shares is to be paid back to the company to such shareholders after the expiry of a stipulated period, whether the company is wound up or not.
As per section (80) 5a, a company after the commencement of the Companies (Amendment) Act, 1988 cannot issue any preference shares which are irredeemable or redeemable after the expiry of a period of 10 years from the date of its issue. It means a company can issue redeemable preference share which are redeemable within 10 years from the date of their issue.
d) Participating or Non-participating Preference Shares
Participating Preferred Stock
These preferred issues offer the holders the opportunity to receive extra dividends if the company achieves some predetermined financial goals. The investors who purchased these stocks receive their regular dividend regardless of how well or how poorly the company performs, assuming the company does well enough to make the annual dividend payments. If the company achieves predetermined sales, earnings or profitability goals, the investors receive an additional dividend.
The preference shares which are entitled to a share in the surplus profit of the company in addition to the fixed rate of preference dividend are known as participating preference shares.
After the payment of the dividend a part of surplus is distributed as dividend among the quality shareholders at a particulate rate. The balance may be shared both by equity and participating preference shareholders at a particular rate.
Thus participating preference shareholders obtain return on their capital in two forms
a) fixed dividend
b) share in excess of profits.
Those preference shares which do not carry the right of share in excess profits are known as non-participating preference shares.
Apart from the above some other preference stocks are also present namely as,
A) CONVERTIBLE PREFERRED STOCK :
Preferred stock (preference shares) that can be converted into common stock (ordinary shares) at the option of the stockholder (shareholder) or as provided in the agreement under which it was issued, at a specified conversion rate.
Holders of this type of security have the right to convert their preferred stock into shares of common stock. This allows the investor to lock in the dividend income and potentially profit from a rise in the common stock while being protected from a fall in the same.
Convertible preferred stock that may be exchanged, at the issuer's option, into convertible bonds that have the same conversion features as the convertible preferred stock.
These are preferred issues that the holders can exchange for a predetermined number of the company's common stock. This exchange can occur at any time the investor chooses regardless of the current market price of the common stock. It is a one-way deal so one cannot convert the common stock back to preferred stock.
B) PRIOR PREFERRED STOCK
Many companies have different issues of preferred stock outstanding at the same time and one of them is usually designated to be the one with the highest priority. If the company has only enough money to meet the dividend schedule on one of the preferred issues, it makes the dividend payments on the prior preferred. Therefore, prior preferred have less credit risk than the other preferred stocks but it usually offers a lower yield than the others.
C) PREFERENCE PREFERRED STOCK
Ranked behind the company's prior preferred stock (on a seniority basis), are the company's preference preferred issues. These issues receive preference over all other classes of the company's preferred except for the prior preferred. If the company issues more than one issue of preference preferred, then the various issues are ranked by their relative seniority. One issue is designated first preference, the next senior issue is the second and so on.
D) EXCHANGEABLE PREFERRED STOCK
This type of preferred stock carries an embedded option to be exchanged for some other security upon certain conditions.
E) PERPETUAL PREFERRED STOCK
This type of preferred stock has no fixed date on which invested capital will be returned to the shareholder, although there will always be redemption privileges held by the corporation. Most preferred stock is issued without a set redemption date.
F) PUTABLE PREFERRED STOCK
These issues have a "put" privilege whereby the holder may, upon certain conditions, force the issuer to redeem shares.
G) MONTHLY INCOME PREFERRED STOCK
A combination of preferred stock and subordinated debt.
( II ) DEPOSITORY RECEIPTS
A depositary receipt is a negotiable financial instrument issued by a bank to represent a foreign company's publicly traded securities. The depositary receipt trades on a local stock exchange.
Depositary receipts make it easier to buy shares in foreign companies because the shares of the company don't have to leave the home state.
When the depositary bank is in the U.S., the instruments are known as American Depositary Receipts (ADRs). European banks issue European depositary receipts, and other banks issue global depositary receipts (GDRs).
( III ) AMERICAN DEPOSITARY RECEIPT (ADR)
American Depository Receipts, or ADR’s are negotiable security ( certificates ) that represents the underlying securities of a non-US company that are traded in U.S. financial Markets that represent ownership in shares of a Foreign Company. Individual shares of the securities of the foreign company represented by an ADR are called American depositary shares (ADSs).
Each ADR may correspond to ownership of a fraction of a foreign share, one share or several shares of the foreign corporation. ADR’s were created to make it easier for foreign firms to satisfy U.S Security registration requirements. They are the most common way for U.S investors to invest in and trade the shares of foreign corporation.
The stock of many non-US companies trades on US stock exchanges through the use of ADRs. ADRs are denominated, and pay dividends, in US dollars, and may be traded like shares of stock of US-domiciled companies.
The first ADR was introduced by J.P. Morgan in 1927 for the British retailer Selfridges. There are currently four major commercial banks that provide depositary bank services: BNY Mellon, J.P. Morgan, Citi Bank, andDeutsche Bank.
( IV ) EMPLOYEES STOCK OPTION PLAN OR SWEAT EQUITY
An Organization to provide an offer to their serving Employees, may allow for a Specified Amount lesser than the Market value, termed as Employees Stock Option Plan.
An ESOP is nothing but an option to buy the company's share at a certain price. This could either be at the market price (price of the share currently listed on the stock exchange), or at a preferential price (price lower than the current market price).
If the firm has not yet gone public (shares are not listed on any stock exchange), it could be at whatever price the management fixes it at.
WHY WOULD A COMPANY OFFER AN ESOP?
Let's first explain what owning a share entails.
When you invest in shares, you do not invest in the market. You invest in the equity shares of a company. That makes you a shareholder or part owner in the company.
Owning an equity share means owning a share in the company business. Companies offer their employees shares because it is considered that having a stake in the company would increase loyalty and motivation substantially.
WHEN ARE THEY GIVEN?
It depends on company policy and your designation. There are time limits for availing this scheme. For instance, you can acquire the shares after you complete a particular period of employment. This could be a year, even longer.
This is known as the vesting period, and generally ranges from one to five years. If you quit your job before this period is complete, the stock options lapse.
Sometimes, the ESOPs are given in a phased out fashion -- 20% in the second year, another 20% in the third year, etc.
WHEN ARE THEY TAXED? The ESOP is not taxed on acquiring the shares. You are taxed on the profit you make when you sell the shares or transfer them.
Transfer here refers to when you gift it to someone or transfer it to someone else under an irrevocable deed (they now own it, not you).
HOW ARE THEY TAXED?
When you sell any asset you own (house, land, shares, mutual fund units, gold, debentures, bonds), and you make a profit on the sale, it is known as capital gain.
The tax you pay on this profit is called the capital gains tax. Capital gains tax is computed on the difference between the sale price and the issue price (the price at which shares are offered to you).
If you sell the shares within a year of allotment (within 12 months of acquiring them), then it is a short-term capital gain. If you sell the shares after a year of allotment (after 12 months of acquiring them), then it is a long -term capital gain.
WHAT MAY HAPPEN IF THEY ARE LISTED ABROAD AND SOLD ABROAD?
This depends on whether you are a resident or non-resident Indian. If you are a non-resident, it will not be taxable, as the gains occur outside India unless the money is received in India.
If you are a resident in India, then you will be taxed on the gains.
Long-term capital gain is taxed at 20%.
Short-term capital gain is added to your overall income and taxed according to your slab rate.
WHAT MAY HAPPEN IF THEY ARE LISTED AND SOLD IN INDIA? The taxability depends on the nature of gain at the time of sale.
If you have a short-term capital gain, you have to pay tax at the rate of 10% (plus surcharge if applicable). Long-term gains are exempt from tax.
DO I HAVE TO PAY A SECURITY TRANSACTION TAX IF SOLD IN INDIA OR ABROAD?
If you sell your shares on or after October 1, 2004, you need to pay the Securities Transaction Tax in India. Also the STT is leviable in abroad as per their rules.
CAN I AVAIL OF INDEXATION?
You use indexation when you calculate tax taking into account the inflation. This is good because it reduces the amount of capital gain and the amount you end up paying as tax.
Indexation is available only for long-term capital gains. Since the long-term capital gains on shares and options are not taxable now, it is not required.
CAN I INVEST THE PROFIT TO AVOID TAX?
Long-term capital gain on shares are exempt, so this does not arise.
There is no provision to invest the short-term capital gains to avoid tax.
( E ) DIFFERENT VALUE RIGHTS ( DVR ) STOCKS
A DVR share is like an ordinary equity share, but it provides fewer voting rights to the shareholder. So, for instance, while a normal Gujarat NRE Coke shareholder can vote as many times as the number of company shares heshe holds, someone who holds the company’s DVR shares will need to hold 100 DVR shares to cast one vote. The number of DVR shares required to be held will differ from one company to another.
Why are these issued by companies?
Companies issue DVR shares for prevention of a hostile takeover and dilution of voting rights. It also helps strategic investors who do not want control, but are looking at a reasonably big investment in a company. At times, companies issue DVR shares to fund new large projects, due to fewer voting rights, even a big issue does not trigger an open offer.
The Companies Act permits a company to issue DVR shares when, among other conditions, the company has distributable profits and has not defaulted in filing annual accounts and returns for at least three financial years.
However, the issue of such shares cannot exceed 25 per cent of the total issued share capital. Some companies that have issued DVR shares on our bourses include Tata Motors, Pantaloons and Gujarat NRE Coke. According to reports, Tata Steel has plans to raise $1 billion through various instruments, including DVR shares.
Who should invest in DVR shares?
It offers both retail and institutional investors a variation, especially for those who may not be as particular about voting rights, but may see economic value in the form of higher discount offer that is being made and also for the incremental dividend.
Why should retail investors invest?
These are, ideally, good instruments for long-term investors, typically small investors, who seek higher dividend and are not necessarily interested in taking a voting position. Although DVR shares are listed in the same way as ordinary equity shares, these trade at a discount, as these provide fewer voting rights to the holder. Investors can also take advantage of the price differential of DVR and normal shares.
When Tata Motors had declared its dividend in 2006, it gave the DVR holders a divided of six per cent and the ordinary shareholders one per cent. For example, the Tata Motors DVR shares were trading at Rs 689.80 on the National Stock Exchange (NSE) and the ordinary ones at Rs 1,255.75 on Wednesday.
What are the disadvantages?
DVR shares are thinly traded scrips, which means these are highly illiquid stocks. On Wednesday, a total of 2,67,000 ordinary shares of Pantaloons were traded on NSE and only 1,154 DVR ones. A total of 44,214 DVR shares of Gujarat NRE Coke were traded on Wednesday and 5,90,000 of the ordinary ones.
