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What is Stockholder Equity?
Simply put, stockholder equity, also known as shareholder's equity, is a company's assets minus its liabilities. It can also be thought of as the amount of capital that investors have put into the company, called paid-in capital, in exchange for company shares. A positive difference between assets and liabilities equals a positive stockholder's equity. This is also commonly referred to as the book value of a company. Companies normally list their stockholder equity on the balance sheet, a financial report that also reviews a company's assets and liabilities.
Stockholder equity is comprised of a company's retained earnings—the money it generates that it's able to keep—and of the money that was originally invested in the company. This makes up a third of what needs to be tallied on a company's balance sheet. The other two thirds of information are a company's assets and liabilities. All of these numbers are related, and must add up in order for a company's books to be considered balanced. Accordingly, it may be calculated simply by subtracting the total number of liabilities from the total number of assets. In some cases, it may also be necessary to subtract preferred stock.
Along with being a single figure used to assess the value of company shares, shareholder equity also comprises an entire section listed on the balance sheet. The figures listed within the stockholder equity section represent the different kinds of equity the company is holding. These numbers include preferred and common stock, treasury stock, retained earnings, and capital surplus. These figures represent the kinds of equity held by shareholders, but not necessarily the value within them. The value of the equity is determined ultimately by the difference between total assets and total liabilities. In cases where a company has performed poorly, it may even be possible for liabilities to outnumber assets, resulting in a negative value of stockholder equity.
Aside from subtracting liabilities from assets, stockholder equity can also be calculated using figures only found within the equity section. This can be done by adding a company's shared capital, or capital surplus, to retained earnings and then subtracting the treasury stock. In order for this number to be wholly accurate, one may need to also subtract the difference between the common stock and other stockholder equity held by the company. This method, though effective, is more tedious than simply subtracting total liabilities from total assets.
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Discussion Comments
Whenever I am looking at investing in a new stock, I always like to take a look at the price over book value of the company. Like the name implies, this measure is just the price of a share of stock divided by the last quarter's stockholder equity.
It takes some experience to get a good feel for the numbers since every industry has its own average P/BV number, but if you find a stock that is on the low end, it may mean the stock is underpriced.
As always, though, you should look at all of the measures of a company's assets and liabilities before buying shares of the company.
It also pays to know the average stockholder equity in the company you are invested in. This figure can also be found on a company's balance sheet. By dividing the average stockholder equity by the company's net income, you get a figure called Return On Equity (ROE) that can be used to assess how well the company is performing versus its competitors. I find this figure particularly useful to track how good of a rate of return I am getting on my stocks.
As a common stockholder I also like to track common equity, which subtracts preferred shareholders from the stockholder equity figure. As a smaller player, I really need to keep my eye on things.
I hold shares in several different companies and I always await the stockholder equity statement as it is a very important indicator of a company's financial health. There is so much that goes into having a good and diversified portfolio, and it pays to know what's happening with your stocks.
After reading this article, I would add that stockholders' equity is generally classified into two major categories, called contributed capital and earned capital. The former is capital that investors have contributed to the corporation through the purchase of stock, while the latter is capital the company has earned since its beginning, but hasn't been paid out to stockholders in the form of dividends.
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