Library/CFA (Chartered Financial Analyst)/Equity Investments (CFA Program Curriculum, 2026 • Level I • Volume 5)/Learning Module 4 Overview of Equity Securities

Learning Module 4 Overview of Equity Securities

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Overview and Importance of Equity Securities5 min

This chapter describes equity securities, their types and features, how they are used to finance companies, and how their characteristics affect investors and valuations. Equity represents ownership in a firm; common shares entitle shareholders to residual claims on net assets and voting rights (subject to share-class provisions) and typically share in firm profits via dividends or retained earnings that drive book value. Preference (preferred) shares rank ahead of common stock on dividend priority and liquidation preference. Preference shares can be cumulative or non-cumulative, participating or non-participating, callable, putable, convertible, or combinations thereof. Each feature changes risk and return for investors: cumulative dividends accrue and must be paid before common dividends, participating preferreds can claim extra dividends or liquidation proceeds, convertibles allow upside sharing with common equity, and put/call provisions set minimum or capped returns, all of which influence valuation and required yield. Companies access capital by issuing common or preference equity or by taking on debt. Private equity markets include venture capital (seed to growth financing), leveraged buyouts (taking a public company private using debt), and private investments in public equity (PIPEs). Private equity is typically less liquid and requires longer holding periods but can provide large returns. Depositary receipts (ADRs, GDRs) and global registered shares allow investors to own foreign equities in local markets and currencies; ADRs have multiple levels (Level I unlisted to Level III listed) with different SEC registration and capital-raising capabilities. Basket listed depository receipts (BLDRs) or ETFs give exposure to collections of receipts. The chapter emphasizes total return for equities consists of dividends and price appreciation; for foreign investments, currency changes create an additional component. Reinvested dividends materially increase long-run wealth compared with price appreciation alone. Risk for equity is driven by the uncertainty of future cash flows (price and dividend variability); relative to common stock, preference shares are typically less risky because dividends are fixed and liquidation preferences are defined. Fixed versus variable operating cost structures influence firm operating leverage; callable securities usually offer higher yield to compensate for call risk; putable securities lower investor risk and therefore pay lower yields. Book value equals assets minus liabilities; market value reflects investor expectations about future cash flows. Return on equity (ROE) is an accounting measure: net income available to common shareholders divided by average book equity. Price-to-book ratios indicate market expectations of future growth; disparities across firms and industries need careful interpretation and are affected by accounting methods. Cost of equity is the company’s expected return required by equity investors and is estimated via models such as the CAPM or dividend discount models; it is a key input to weighted average cost of capital (WACC), which combines after-tax cost of debt and cost of equity weighted by capital structure. The chapter illustrates these concepts with company examples (Pfizer, Novartis, GlaxoSmithKline) and practical computations of ROE, price-to-book, book value per share, and WACC. It also highlights special corporate structures such as dual-class shares (e.g., Viacom, Ford), where different classes carry differing voting or liquidation rights, affecting governance and valuation. Finally, the chapter summarizes that understanding the various equity instruments, their contractual and economic features, and how they interact with corporate finance and market expectations is essential to valuing securities and making investment decisions in global markets.

Key Points

Equity represents ownership and includes common and preference shares.
Preference share features (cumulative, participating, convertible, callable, putable) alter risk-return profiles.
Private equity (VC, LBO, PIPE) differs from public equity in liquidity and structure.
Depositary receipts and global registered shares facilitate foreign investment.
Total equity return = dividends + price change (+ currency effects for foreign securities).
Book value vs. market value: market value reflects expectations of future cash flows.
ROE and price-to-book assist in assessing firm performance and market expectations.
Cost of equity and WACC are essential for valuation and capital budgeting.

Questions

Question 1

Which of the following best describes common shares?

Learning Module 4 Overview of Equity Securities

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