Advantages and Disadvantages of Ordinary Shares

Ordinary shares, also referred to as equity shares or common stocks, represent a fundamental component of the equity market and are a primary vehicle through which investors can gain ownership in a company. These shares provide individuals with various rights and privileges that can be highly appealing to those looking to invest in businesses. However, while owning ordinary shares presents several advantages, it also comes with notable risks and disadvantages. To fully appreciate the benefits and challenges of investing in ordinary shares, it is important to explore both the advantages and disadvantages in depth, allowing investors to make informed decisions about their investment choices.

One of the main advantages of ordinary shares is the right to vote at a company’s annual general meeting (AGM). Shareholders with ordinary shares are granted the ability to influence company decisions by voting on important matters such as the election of the board of directors, the approval of financial statements, and other key corporate policies. The voting rights are typically one vote per share, allowing shareholders to have a proportional say in the management and direction of the company. This democratic right allows investors to actively participate in corporate governance, providing them with a direct influence over who is in charge of making decisions on behalf of the company. Voting rights can be especially valuable for investors who want to ensure that the company is being run in a way that aligns with their interests and values. They can use their votes to elect board members they believe will act in the shareholders' best interest and contribute to the company’s long-term success.

In addition to voting rights, ordinary shareholders are considered the owners of the business. This ownership gives them a claim on the company’s profits, which is distributed in the form of dividends. When a company generates profit, it may decide to share a portion of that profit with its shareholders in the form of dividends, which are often expressed as a fixed amount per share. For example, if a company declares a dividend of $2 per share, an investor holding 100 shares would receive $200 in dividends. The amount of dividends that ordinary shareholders receive depends on the company’s profitability and the decisions made by the board of directors. Dividends can provide a steady source of income for shareholders, especially for long-term investors who seek to benefit from both capital appreciation and regular dividend payouts. In many cases, these dividends are paid quarterly, annually, or at other regular intervals, depending on the company’s dividend policy.

Another significant advantage of holding ordinary shares is the potential for capital appreciation. When a company performs well, the market value of its shares can rise, leading to increased wealth for shareholders who choose to sell their shares at a higher price than they initially paid. This potential for growth makes ordinary shares an attractive investment for individuals seeking to capitalize on the success and expansion of a business. Companies that grow their revenues, enter new markets, or develop innovative products often experience rising stock prices, which benefits shareholders. Unlike other types of investments that may have fixed returns, ordinary shares offer the potential for unlimited upside, making them appealing to investors with a higher risk tolerance who are seeking significant returns.

However, despite these advantages, investing in ordinary shares comes with certain disadvantages, many of which are tied to the risks associated with this form of investment. One of the most notable disadvantages is that ordinary shares are among the riskiest types of investments. While shareholders may benefit from dividends and capital gains during prosperous times, there is also the real possibility of no dividends being paid in certain years. The payment of dividends is never guaranteed and is at the discretion of the board of directors. In periods of financial difficulty, a company may decide to withhold dividends to conserve cash, reinvest in the business, or pay down debt. This means that ordinary shareholders are exposed to the risk of not receiving any income from their investment if the company underperforms or faces challenges such as economic downturns, changes in market demand, or increased competition.

Additionally, the value of ordinary shares is subject to market volatility, which can lead to substantial fluctuations in share prices. If the company’s performance deteriorates, its stock price may decline, resulting in a loss for shareholders who choose to sell their shares. Market factors, such as investor sentiment, changes in industry conditions, and broader economic trends, can all have a profound impact on the value of ordinary shares. Unlike other forms of investments that may provide more stable or predictable returns, such as bonds or real estate, the performance of ordinary shares can be unpredictable, making them a risky choice for conservative investors or those with lower risk tolerance.

Another disadvantage of owning ordinary shares is that shareholders bear the operational risks of the organization. As part-owners of the company, shareholders are directly impacted by the company’s operational decisions and performance. If the company struggles with issues such as poor management, inefficiency, or ineffective business strategies, shareholders may experience negative consequences in the form of lower dividends, reduced share value, or even complete financial loss. Furthermore, ordinary shareholders are at the bottom of the priority list in the event of liquidation. If the company goes bankrupt or is liquidated, creditors, bondholders, and preferred shareholders have a higher claim on the company’s remaining assets. This means that ordinary shareholders may not receive anything if the company’s assets are insufficient to cover its debts and obligations. In this sense, ordinary shareholders are the most exposed to the operational risks of the company and stand to lose the most in adverse situations.

A more specific disadvantage tied to ordinary shares is the potential dilution of ownership. When a company issues new shares to raise additional capital, the number of shares in circulation increases. This can dilute the percentage of ownership held by existing shareholders, reducing their voting power, claims on dividends, and overall influence over company decisions. Dilution can occur during various corporate events, such as public offerings of new stock or stock splits. For example, if a company issues more shares to fund an acquisition or expansion project, existing shareholders may find their stake in the company diminished. Although the issuance of new shares can be a sign of a company’s growth or financial strategy, it can also reduce the value of existing shareholders' investments, especially if the additional shares lead to reduced earnings per share or dividend payouts.

Furthermore, the issuance of new shares can also impact the market price of the stock. When new shares are introduced to the market, the increased supply can put downward pressure on the stock price, especially if the market perceives the issuance as a sign of financial instability or an attempt to raise capital in an urgent manner. This can lead to capital losses for existing shareholders who may see the value of their investment decline in response to the dilution of ownership.

While the potential for dividends and capital appreciation offers substantial rewards to investors in ordinary shares, the risks involved make it a less attractive option for those seeking guaranteed returns or lower risk exposure. Ordinary shares are inherently volatile, and investors must be prepared for the possibility of fluctuating stock prices and uncertain dividend payments. Additionally, the operational risks of the company, including the risk of financial failure and the possibility of dilution, further increase the uncertainty associated with investing in ordinary shares.

Ordinary shares represent a fundamental investment opportunity, providing individuals with ownership stakes in companies, voting rights, and potential income in the form of dividends. They allow investors to participate in a company’s growth and success while offering the potential for capital gains. However, the risks of ordinary shares cannot be overlooked. The lack of guaranteed dividends, exposure to operational risks, and the possibility of dilution make them one of the riskiest forms of investment. As such, ordinary shares are best suited for investors who are willing to take on higher levels of risk in pursuit of potential rewards. Careful consideration of both the advantages and disadvantages is essential for anyone looking to invest in ordinary shares, ensuring that their investment strategy aligns with their financial goals and risk tolerance.