What Is Equity in Investing?
Definition & Examples of Equity in Investing
The term "equity" can refer to a few different things in the world of investing. It can describe individual shares of stock, overall balance sheet value of a company, or ownership in a private enterprise.
In all of these cases, equity communicates something important to an investor, so it's important to know what each means and how to understand which one the word refers to in different contexts.
What Is Equity in Investing?
When you hear the term "equity" in relation to investing, it usually means one of three things:
- Shares of stock that an investor owns
- The total shareholder equity in a particular company
- The alternative ownership structure of private equity
How Equity Works in Investing
Although these different types of equity are all important for an investor, they signify very different things.
Equities as a Synonym for Shares of Stock
The term "equities," when used in the plural, is universally shorthand for shares of common stock, though you will sometimes also hear it used to refer to shares of preferred stock, which are often convertible into common stock. If someone mentions their "equity portfolio," they're talking about their stock holdings.
Equities are securities that confer an ownership stake to the holder. After you've purchased, say, 1,000 shares of McDonald's, you can claim you own a (very small) piece of the restaurant chain.
Equity as a Balance Sheet Concept
In almost all cases, "equity," when used in the singular, refers to the broad concept of ownership or a balance sheet accounting value—namely, shareholders' equity. This figure lets an investor know how much money is left for owners of a business if all accounting liabilities are subtracted from all accounting assets. Note that shareholder equity is not the same as net tangible assets, or book value, because net tangible assets exclude intangible assets such as goodwill while shareholders' equity includes them.
For some businesses, shareholders' equity is extremely important and useful in determining what the company is truly worth. For other businesses—those that don't require a lot of assets to generate income—balance sheet equity is of limited utility. An example of the former would be General Motors Co., which needs large manufacturing facilities to make its cars. An example of the latter would be software company Oracle, which relies on programmers sitting at desks to create its software.
Shareholder equity communicates something important about the financial health of a company. Generally speaking, negative shareholder equity means that the company doesn't have enough money to pay off its debts if it had to liquidate its assets. This is typically a red flag for an investor.
Equity as Part of "Private Equity"
The term "private equity" refers to an entirely different type of ownership structure than that for publicly traded equities. If someone talks about their private equity holdings, it usually means they have a stake in a limited partnership or some other legal entity that is run by a private equity manager. The private equity manager takes the partners' money and invests it in privately held companies that are not traded over the counter or on a stock exchange.
Private equity managers usually reorganize businesses with the intention of either selling them to another buyer or exiting through an initial public offering within five to seven years. In exchange for sacrificing liquidity and taking on greater risks, private equity investors expect, but do not always experience, higher returns on their investment than investors in publicly traded equities.
Private equity managers frequently specialize. For example, certain private equity managers may prefer to take over packaged food companies. Some might be experts in completing leveraged buyouts, placing loads of debt on their target businesses. Some might have experience in turnarounds, taking a troubled company and restoring it to profitability. Some might work with companies in a specific size range and use one to roll up competitors to create a larger, more efficient enterprise. A private equity investor would choose which of these types of investments makes sense for them.
Private equity investors should be careful to look out for undisclosed fees and conflicts of interest in private equity funds.
Private equity is usually differentiated from venture capital in that private equity typically involves the total acquisition of 100% of a company's equity during the restructuring phase, while venture capital usually involves taking a partial stake in a highly promising startup company. Private equity owners usually must be so-called accredited investors, who are capable of meeting minimum net worth and income requirements, either alone or in combination with a spouse.
Private equity is also differentiated from hedge funds in that many hedge funds focus on investing in ("going long") or betting against ("shorting") publicly traded equities, though some also do private-equity-type deals.
- Equity can refer to a few things in the investing world: shares of stock, total shareholder value, or investing in private equity firms.
- Equity as shares of stock can also mean an entire investment portfolio.
- Total shareholder equity refers to a company's balance sheet value and its ability to pay off its debts if it were liquidated.
- Private equity investing is done through a private equity manager and is usually distinct from investing in publicly traded companies.