Stockholders' equity is the value of a firm's assets that remain after subtracting liabilities. This amount appears on the balance sheet as well as the statement of stockholders' equity.
Learn what it means for a company's value and how it should inform your decisions.
What Is Stockholders' Equity?
Stockholders' equity is the money that would be left if a company sold all its assets and paid off all its debts. What would be left over is the money that belongs to the owners of the company. This includes its stockholders, who are partial owners. It is the net worth of a company.
It can also be called "owners' equity" or "shareholders' equity." It can be found on a firm's balance sheet and financial statements, along with data on assets and liabilities.
Stockholders' equity shows the quality of a firm's economic stability; it also provides insights into its capital structure. Find it on the balance sheet is one way you can learn about the financial health of a firm.
Alternate names: shareholders' equity, book value, owners' equity, net worth
How Does Stockholders' Equity Work?
Stockholders' equity usually comes from three sources:
- Capital stock: This is cash or other assets paid in by investors when the company was raising capital; this is in exchange for issuing shares of common stock or preferred stock.
- Paid-in surplus: This is capital given by investors in exchange for stock; this doesn't include stock from money generated from earnings or donations (also known as paid-in capital).
- Retained earnings: These are accumulated profits a business has held on to for reinvestment in the firm. It has not paid this out to its shareholders as dividends or used it in the repurchase of stock.
A firm's balance sheet will often feature two columns: a left column listing its assets, and a right column showing its liabilities and owners' equity. Some balance sheets will list assets at the top, then liabilities; finally, stockholders' equity is at the bottom.
In either case, total assets should equal the total liabilities plus owners' equity.
A balance sheet provides a snapshot. It tells you about a company's assets, liabilities, and owners' equity at the end of a reporting period.
Shareholders' equity on a balance sheet is adjusted for a number of items. For instance, the balance sheet has a section called "Other Comprehensive Income." It refers to revenues, expenses, gains, and losses; these aren't included in net income. This section includes items like translation allowances on foreign currency and unrealized gains on securities.
Stockholders' equity increases when a firm generates or retains earnings. This helps balance debt and absorb surprise losses. For most firms, higher owners' equity means a larger cushion. This provides more flexibility to recover in the event that the firm experiences losses or must take on debt. This could be due to poor underwriting or an economic recession, among other reasons.
Unlike creditors, shareholders can't demand payment during a difficult time. This allows a firm to dedicate its resources to fulfilling its financial obligations to creditors during downturns.
Lower stockholders' equity is sometimes a sign that a firm needs to reduce its liabilities. But this is not always the case. For some businesses, especially those that are new or conservative and have low expenses, lower stockholders' equity is not a problem.
Stockholders' equity has less meaning for these companies. That's because it doesn't take much money to produce each dollar of surplus-free cash flow. In these cases, the firm can scale and create wealth for owners much more easily. This is true even if they are starting from a point of lower stockholders' equity.
Alternatives to Stockholders' Equity
When making investment decisions, stockholders' equity is not the only thing you should look at. A single data point in a company's financial statement cannot tell you whether or not they are a good risk.
Look at stockholders' equity on a balance sheet for more informed investing. But you should also look at:
- Annual reports: These are yearly statements on a company's financial situation; they may also include details on goals, management, leadership, and culture.
- Form 10-K: This filing is required by the Securities and Exchange Commission (SEC). It provides an overview of a company's financial condition; it's sometimes sent to shareholders in place of an annual report.
- Debt-to-equity ratio: This compares assets to liabilities. It can help you identify a company that carries too much debt.
- Price-to-earnings ratio: This compares the price of shares to the per-share earnings of the company; higher ratios indicate more potential for growth.
- Industry stability and growth: This provides context on the company's potential opportunities for profitable growth.
- Dividends: These can indicate stability and growth, unless dividends make up too high a percentage of profit.
- Income statement: This allows you to compare earnings, expenses, and net profit over time.
When examined along with these other benchmarks, the stockholders' equity can help you formulate a complete picture of the company and make a wise investment decision.
- Stockholders' equity is the value of a business' assets that remain after subtracting liabilities, or its net worth.
- This amount appears in the firm's balance sheet, as well as the statement of stockholders' equity.
- For most companies, higher stockholders' equity indicates more stable finances and more flexibility in the case of an economic or financial downturn.
- Understanding stockholders' equity is one way investors can learn about the financial health of a firm.