Difference Between Shares And Debentures

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  • 18 Sep 2023

Shares, for instance, denote ownership stakes in a company and offer potential for capital appreciation and dividend prospects. However, they are volatile and susceptible to market fluctuations. In contrast, debentures are like loans extended to a company, offering fixed interest payments. Generally, they have lower growth potential. So, there exist some fundamental differences between shares and debentures. Let’s explore them in detail.

A share represents a unit of ownership in a company or a financial asset . When you buy shares, you become a shareholder, and you own a small part of the company. The number of shares you own determines your percentage ownership of the company. Shares can be bought and sold on the stock market. The stock exchanges facilitate this by acting as an intermediary between the companies and the investors. As the shares of a stock are traded continuously, their prices keep on changing. As a principle, the price of a share is determined by supply and demand. If more people want to buy the shares than sell them, the price will go up. If more people want to sell the shares than buy them, the price will go down.

A debenture is a type bond or a type of debt instrument which is unsecured by collateral. Since debentures have no collateral backing, they must rely on the creditworthiness and issuer for support. Both corporations and governments frequently issue debentures to raise capital or funds. Due to this, in India, debenture holders are given priority over other creditors when a corporation files for bankruptcy.

Debentures are usually considered a lower-risk investment as compared to shares. You are guaranteed to receive your interest payments, even if the performance of the company declines. However, there's one thing to note. Investors do not get a share in the company's profits.

Now that you know what shares are and what are debentures, let’s take a detailed look at the difference between shares and debentures. The following are the noteworthy ones on the basis of different parameters:

1. Ownership

Shares signify ownership in a corporation. In contrast debentures, which are debt instruments and do not grant you any ownership rights,. You will have a portion of ownership in a corporation if you hold shares in it. You will become a company's creditor if you purchase debentures.

2. Returns

Dividends and share price growth are the two main ways that investors may profit from their investments. Conversely, Debentures provide fixed interests. Whether the business is profitable or not, interest is paid to holders of debentures. Dividends are only given to shareholders when the business is profitable.

3. Voting Rights

Common shares offer voting rights. So, the shareholders can have a say in the key decisions of the company. However, neither convertible nor non-convertible debentures give voting rights to their holders. So, even though debenture holders are considered as creditors of a company, they don’t have a say in the company.

4. Liquidation

A firm may fail for a number of reasons, including a weak market, financial loss, debt, or a lack of capital. In these situations, it sells all of its assets to cover its debts and other commitments. Debenture holders are paid before shareholders in the event of a liquidation. The final group to get money is shareholders.

5. Conversion

Equity shares cannot be changed into debentures. On the other hand, after a predetermined amount of time, debentures can be converted into shares. Fully convertible debentures are those that can be converted into a company's equity shares for its whole face value.

6. Security

Shares are subject to changes in market conditions, supply and demand, business performance, governmental regulations, and other variables. Therefore,they are a riskier type of investment. Debentures have got no security to support them, but the corporations that issue them often have a sound financial foundation. In addition,holders of debentures receive regular payments depending on either fixed or fluctuating interest rates.

Here’s the key difference between shares and debentures at a glance. You can simply go through the below table to quickly understand the main difference between these two terms:

Feature Shares Debenture
Ownership StatusInvestors get a stake in the companyDebenture holders are creditors to the company
Voting RightsCommon shares confer voting rights to investorsDebentures don’t offer any voting power
Form Of ReturnsCan give a share in the company’s profitsGuaranteed payments as fixed interests
RiskRiskier than debenturesLow risk investments
Upon Liquidation Of CompaniesRepayment after clearing the liabilitiesPrioritised over repayment to shareholders
Trust DeedNot requiredRequired

Shares can indeed be a smart alternative if you are really seeking for a financial investment with high return potential. But, debentures can prove to be a good low risk investment. Before making any investment, it is crucial to conduct thorough research and speak with a financial advisor. Well-known financial firms often have a team of experienced professionals who can assist you. You can find the right piece of advice from trusted firms like Kotak Securities that offer curated investing tips based on your investment goals.

Here are some crucial things to consider when choosing between shares and debentures:

  1. The investment approach: Your choice between these two investment instruments will highly depend on your wish to invest in the share market. Some investors may look to invest for a very short period of time. However, others may remain invested for a long time following the principles of long-term investing.

  2. Investor’s risk tolerance: How much risk are you willing to take is the next big factor. One should invest according to his risk appetite. So, the amount of shares and debentures you hold in your portfolio depends on how much risk exposure you want to take.

  3. Your financial situation: How much money do you have to invest? That’s the next question you should ask yourself. Always invest the funds that you can afford to lose. Don’t be unrealistic in your approach.

  4. Your investment objectives: The goals you have set for yourself are vital too. The amount of return you want will decide how much you will invest in different kinds of securities.

  5. Liquidity: Shares are generally more liquid than debentures. This means that you can buy or sell shares in your portfolio more easily. In most cases, it is easy to find both buyers and sellers for stocks trading on major stock exchanges.

  6. Tax treatment: All financial instruments are taxed differently. Moreover, the rules governing them can also change from time to time. It is thus very important to seek the help of a tax advisor to understand the tax implications of all your investments.

  7. Credit risk: The credit risk of a debenture means that a company will not be able to repay the loan. The credit risk of a share implies that a company may not turn out to be profitable. Hence, the stock price is bound to fall. By considering all these vital factors, you can certainly make informed decisions regarding your investment choices. Understanding these fundamentals of value investing will better position you to find out which type of security is right for you.

Conclusion

Shares and debentures represent diverse investment options. Both offer distinct choices, each with its own unique characteristics and associated risks. Shares give ownership in a company and offer the potential for capital appreciation and dividends. However, they are volatile and subject to market fluctuations. On the other hand, debentures are like loans provided to a company, offering interests. Although they have low growth potential, they are more stable than shares.

Yet there is a credit risk, which depends on the financial health of issuers. The decision between these investments depends on your specific financial goals and your willingness to take risks. The key to success entails building a balanced portfolio that includes a right mix of both shares and debentures.

FAQs on Difference Between Shares And Debentures

To list itself on stock exchanges, every company must issue shares. However, it is not mandatory to issue debentures.

The returns from shares depend on capital appreciation and dividends. Debentures earn you fixed interests.

Some companies may occasionally offer convertible debentures, which you can convert into shares at a certain predetermined rate. However, the practice of converting shares into debentures is not very common.

Since debenture holders are creditors of the company they are prioritised over other investors including shareholders. Debenture holders have higher chances of recovering their investments.

Shares don’t have a maturity date. However, debentures have a predetermined maturity date when the companies must repay the principle.

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