What is Equity

Equity represents a proportionate ownership in a company’s business.

When you buy equity shares of a company, you own a certain part of that business, and are entitled to your proportionate share of dividends & voting rights in the business. The value of the equity that you own is determined by the value of the business. 

Business Value Increases

Your equity value increases (i.e. you make capital gains)

Business Value Reduces

Your equity value falls (i.e. you make capital losses)

As the business value rises or falls over time, the value of your equity will rise or fall respectively.

Equity is all around us

As consumers, we are constantly consuming the products & services of various businesses that are listed on the stock exchanges. As our consumption increases (for the economy as a whole), so does the demand and the profits for these companies. 

As an example:

  • Everyday consumption: when we buy more soap, shampoo, snacks, curd etc. we increase demand for FMCG companies (HLL, Nestle etc.). The more clothes we buy, the greater the demand for branded apparel (Page, Bata etc.). 
  • Home renovations: leads to a direct increase in demand for paints (Asian Paints, Berger), brown-goods (Havells, Crompton, Bajaj) and durables (Voltas, Blue Star, Whirlpool)
  • Discretionary demand: such as the purchase of a car (Maruti, M&M) or a bike (Hero, Bajaj)
  • Medical: we use medicines when we are sick (Sun, Dr. Reddys) and sometimes have to go to hospitals (Apollo, Fortis)
  • Financial services: we take loans from banks (ICICI Bk, HDFC Bk) or from NBFCs (HDFC, LIC HF) or use capital market firms (Edelweiss, Birla Capital) to invest our money 
Apart from consumer companies, there are also companies that focus on supplying to businesses & the government. These include
  • IT companies: the create the IT infrastructure & software for global companies
  • Metals: such as steel and aluminium that are used to build infra & consumer goods
  • Infrastructure: companies that build roads, ports, airports and power plants


As the economy grows, the demand for various goods & services grows, which leads to an increase in profits for listed companies. Not all companies & industries will grow at the same pace, which is why portfolio construction is often best left to professional fund-managers who have the skills to analyse what stocks offer the greater upsides. 

However, the basic premise of equities is simple. When you buy equity (either directly of via a MF), you become a part-owner of a business. As the value of this business grows over time, so will the value of your equity. 

What determines the value of a business?

While there are many different techniques of valuing a business, the most commonly used approach is P/E (price-earnings)

Earnings * Valuation multiple = Business Value

For business value to increase, either the company’s earnings need to grow or the valuation multiple needs to increase. These 2 factors often tend to move together as investors are willing to pay a higher multiple for companies that can grow earnings faster. 

There are a very large number factors that lead to how earnings and valuation multiples (and therefore business value) change over time. This is a complex exercise involving many moving parts that is best done by investment professionals. 

However it is possible to get a broad sense of what leads to fluctuations in business value, by understanding some of the more common factors that lead to changes in earnings & valuation multiples. 


  • Economic & Industry growth
  • Pricing power
  • Costs pressure
  • Capital requirements
  • Interest rates, taxes & more

Valuation Multiples

  • Business growth outlook
  • Barriers-to-entry & Competitive dynamics
  • Return ratios, BS strength etc.
  • Investor Sentiment
  • Mgmt quality, governance & more

Equity stocks vs. Equity mutual funds (MFs)

Changes in any of the factors mentioned above (and a host of others) can positively or negatively impact the value of a single business. Specific situations can also lead to a single company losing value, even when the broader economy and markets are doing well. 

Keeping track of all the different factors that impact business value (and how these change over time) is a complex exercise that is not feasible for most individual investors. This is what makes investing in direct equities risky

Equity Mutual funds provide you a low-cost way to have your money managed by a professional fund manager, who makes the decisions of what companies to buy or sell on your behalf. 

Equity MF's invest in a diverse portfolio of companies, reducing single company risk.

By investing in a diversified portfolio of companies across sectors, your investment returns are linked more to economic growth and overall market performance, than to the fortunes of any one specific business. 

Understanding LT Market Returns

The markets are nothing but a sum total of the value of all listed companies. As the fundamental value of these companies rise, the markets rise. When the value of companies fall, the markets fall. Similar to individual stocks, market value is determined by the 2 same key factors – Market Earnings & Market valuations

The value of a market tends to move up in a strong economy and reduce in a weak economy. 

Strong Economy

Weak Economy

Over the longer-term, as long as the economy is growing you will make attractive returns on equity. 

Economic cycles are extremely hard to predict in advance. Trying to time the economy & the market leads to most investors following market performance and buying high & selling low. It is highly recommended not to try to time the markets.

If you invest for the long-term, you will have some great years, some average years and some bad years. This tends to average out to the high mid-teen returns that equity has delivered over the longer-term historically.

Ignore Short-term Market Performance

While markets are driven by business fundamentals over the long-term, the short-term performance of the markets is similar to that of a casino. This is because of the very large impact that newsflow in the short-term can have on market performance. 

The longer-term growth of business value (that get’s reflected in LT market returns) is a lot more stable and predictable, than the wild fluctuations seen in markets in the short-term. 

Market sentiment can swing wildly in the short-term for any host of factors (not linked to underlying fundamental business value). This can include large technical buying or selling pressure, the build up of derivative positions, geo-political tensions, fluctuations in commodity prices, rumors, regulatory changes, political dynamics changing, weather, algorithm trading and more. 

All of these often have little impact on longer-term fundamental value creation by listed companies, but can lead to wild fluctuations swings in the short-term

Large market volatility in the short-term has little impact on your longer-term returns and is ignored by all well-informed investors.