What is trading on equity?
Trading on equity is what corporations resort to for the purpose of increasing their earnings on common stock. They use bonds, other debt, and preferred stock for the job. As an example, consider this: in order to earn more than the interest on the debt, a corporation may consider using long-term debt to purchase assets. This earning which is in excess of the interest expense on the new debt will increase the earnings of the corporation’s stockholders. This increase in earnings is an indication that the corporation successfully carried out trading on equity. However, if the newly purchased assets earn less than the interest expense on the new debt, the earnings of stockholders will decrease. This is an indication that the corporation was unsuccessful in carrying out trading on equity.
Trading on equity is also sometimes referred to as financial leverage or the leverage factor.
What are the effects of trading on equity?
Trading on equity is a lever for amplifying the influence of fluctuations on earnings. Any fluctuations before interest and taxes (EBIT) are magnified on the earnings per share (EPS) with trading on equity. Bigger than the magnitude of debt in capital structure, the higher is the variation in EPS as per the variation in EBIT.
Trading on equity is experiencing new highs
Many online discount broking firms are bringing a wave of innovations to equity trading. They are looking to disrupt the equity trading habits of investors by reducing the cost of trading in shares through use of technology and service bundles. Several market pundits are expecting the meager 10-15% market share of discount broking segment to expand to 40-50% in the next 2-3 years. This segment is growing by leaps and bounds every year as compared to traditional broking segment. The pundits believe that technology is playing a great role in making this disruption a reality.
Going forward, broking houses will base their profitability on technology rather than commissions. Broking firms that offer faster and better trading platforms will have an edge over their competition in the business.
The good news is that broking houses now charge a flat fee of anywhere between INR 15-20 per transaction instead of the 0.04-0.2% fee incurred on the traded amount, thus bringing down the charges by 95%! What also should be noted is that it gives you a perspective on the amount of money you end up spending on bundled services that lack transparency. Meaning, you don't know what you are paying for.
Some of the broking firms also offer exposure up to 4 times the cash balance for delivery. For eg., if an investor has INR 1 lakh in his account, he can leverage its position and still buy stocks up to INR 4 lakh. In other words, it is a temporary loan that an investor or a trader takes from his brokerage to fund share purchases that he can’t immediately fund himself. The debit balance on such funding will attract an interest of 0.05% per day. And if there is no ledger debit at the end of the day, no interest will be charged. Margin funding facilities give traders access to temporary and long-term funding for the purpose of cash market purchases.
All in all, trading on equity is finding its way into the regular investors list of things to do for the purpose of making profits. And with the advent of technology and robust platforms for trading (both desktop and mobile), trading on equity is likely to garner votes from investors with varying portfolios.