Difference Between Shares and Debentures
An investor in the share market must be familiar with few terms that will make investing decisions easier. Let us take out time to learn about shares/stock and debentures in this article. Equity and debt are the 2 major ways by which a company can raise money for its growth and expansion.
When a company takes the equity route, it issues shares to the public and those who buy shares get the opportunity to take part in the company’s growth story. The other route is debt, by which a company can get loan from the public and promises to pay interest on the loan on a regular basis and hence issues debentures to public and those who buy debentures are called as creditors.
What are shares?
If you buy shares of a company, you simply become the owner of the company and your ownership is determined in relation to the number of shares you own. As a shareholder in a company, you get certain rights; voting rights, can receive dividends and you can sell whatever shares you have to someone else at any point of time and earn money.
The two types of stocks are common and preferred stock. As a common stockholder, you can receive dividends and have voting rights whereas a preferred stockholder does not have voting rights and is awarded priority in terms of repayment when the company goes bankrupt.
What are debentures?
Debenture is a kind of debt instrument through which a company raises long term loan. It is not secured and is backed by the creditworthiness of the issuer alone. Debentures pay a fixed interest rate and debenture holders do not have any voting rights as they are creditors and not owners like that of shareholders.
The two types of debentures are convertible and non-convertible. In case of convertible debentures, you can convert debentures into shares at your will whereas this is not possible in case of non-convertible debentures (NCD). NCDs can be secured or unsecured and the interest rate offered by unsecured NCDs is comparatively higher than the secured NCDs. Credit agencies give ratings to the companies that issue debentures based on their creditworthiness.
Take a look at the meaning of credit ratings given by ICRA. You should check this rating before buying NCD.
- AAA – Highest degree of safety
- AA - High degree of safety
- A - Adequate degree of safety
- BBB- Moderate degree of safety
- BB – Moderate risk of default
- B – High risk of default
- C – Very high risk of default
- D- Companies are in default are expected to be in default soon
Risks in NCD investment:
There are certain risks associated with debentures such as inflationary risk, interest rate risk and default risk. In case of inflationary risk, the interest rate offered by the debentures may not be adequate to beat inflation. Sudden change in interest rates may cause loss to the debenture holders which are termed as interest rate risk. You may face default risk when the issuing company faces financial problems.
Points to note while buying NCD:
- 1. Check the credit rating of the company
- 2. Do proper research about the company’s financial strength
- 3. Check past performance of the company
How to buy shares and debentures?
You can buy shares when company comes out with IPO (Initial Public Offer) or you can trade in shares in the secondary market after the company gets listed on the exchange. Similar to shares, you can buy debentures when they are issued for the first time or can buy them in secondary market. You need a demat and trading account to buy shares and debentures.
Difference between shares and debentures:
|1||Definition||Represents ownership/equity||Represents debt|
|4||Convertibility||Cannot be converted to debentures||Some debentures can be converted to equity|
|6||Shareholders/Debenture Holders||Are owners||Are creditors|
|7||Types||Common and preferred stock||Convertible and non-convertible|
Based on one’s needs, equity or debentures can be chosen. It all depends on your risk appetite as well. If you wish to get regular interest and if safety is your priority, choose debentures. Whereas if you are willing take high risks and high returns are what you want, invest in shares. Have a clear understanding of debentures vs shares before investing.