What is Stockholders' Equity?

Stockholders’ equity is like the part of the pizza you have left after your friends get their share…

Your friends help you move into a new apartment, and you promise to buy them pizza in return. The whole pizza is an asset, and the pieces you’ve promised to your friends represent a liability. After they get their slices, the rest of the pie is yours. That part is like a company’s stockholders’ equity - the value left for the owners after the assets are used to pay off the debts.

Stockholders’ equity is the value of the owners’ stake in the company. It’s basically the company’s net worth that appears on its balance sheet, the difference between its assets and its liabilities. It’s also known as shareholders’ equity or book value.

Another way to look at stockholders’ equity is that it’s the liquidation value of a company. Suppose a company goes out of business. It sells all its assets, and uses the cash to pay all its debts. The money that’s left is the shareholders’ equity, and it goes to the company’s owners. The shareholders’ equity should be a positive number, meaning it has more assets than liabilities, but a poorly performing company might have negative shareholders’ equity, meaning it owes more than it has. In that case, shareholders would get nothing if the company liquidates.

Looking at the stockholders’ equity on a company’s balance sheet, as well as the statement of shareholders’ equity included in a company’s financial statements, can be useful for shareholders. It can give them an idea of the company’s financial health and valuation. Investors can also see what a company does with its profits. Does it hang onto them? Does it pass them along to shareholders in the form of dividends? Does it use them to buy back shares?

A company’s stockholders’ equity appears on its balance sheet. It includes these components.

1. Par value of issued stock: When companies form, they often have to designate a par value for their stock. The par value isn’t what they actually sell the stock for. It represents the value of the stock in the company’s charter or articles of incorporation.
2. Additional paid-in capital: Investors rarely pay par value to buy a company’s stock. Many companies intentionally set par value very low. So companies don’t report just their stock’s par value, but also the amount that shareholders paid above the par value to purchase the stock.
3. Retained earnings: Retained earnings are the net income that a company has earned over its history but hasn’t distributed to stockholders in the form of dividends.
4. Treasury stock: When a company repurchases its own stock from shareholders, it becomes treasury stock held by the company. The value of these shares reduces shareholders’ equity.
5. Accumulated other comprehensive income (AOCI): Companies record certain gains and losses that aren’t included in their net income - gains and losses on pension plans or derivatives, for instance. Often they’re “unrealized,” on paper only - an investment owned by the company rises or falls in value, but there hasn’t been a purchase or sale that would lock in the gain or loss. When a purchase or sale does happen, the gains or losses go into net income. Until then, they’re included in AOCI and go into calculating the company’s stockholders’ equity.

If you’re trying to figure out how to calculate stockholders’ equity for a company, all you’ll need is its balance sheet, which includes its assets and liabilities.

A company’s assets are anything the company owns that has value. Assets can include cash, physical assets such as buildings or real estate, or intangible assets such as trademarks and goodwill.

Liabilities are a company’s obligations, money that it owes. Liabilities can include long term obligations such as the loan on a building. It can also include the expenses that the company has incurred but hasn’t yet paid for.

Once you know the company’s assets and liabilities, you can use this shareholders’ equity formula:

Shareholders’ Equity = Assets — Liabilities

Suppose an auto manufacturer has a balance sheet that includes $100,000 in assets and $35,000 in liabilities. If you subtract the liabilities from the assets, you’ll find that the company has a shareholders’ equity of $65,000. If the company were to liquidate tomorrow, that’s how much the shareholders would get.

Stockholders’ equity is also calculated in its own section of the balance sheet - it’s the sum of the capital the company has raised by issuing stock, its retained earnings, and other factors. This method of calculating stockholders’ equity is different, but it yields the same result as calculating it by subtracting liabilities from assets.

A statement of stockholders’ equity is one of the four financial statements that publicly held companies must create and file with the Securities and Exchange Commission (SEC) to make available to shareholders and potential investors. (The others are the balance sheet, the income statement, and the cash-flow statement.)

The statement of shareholders’ equity is a more detailed version of the stockholders’ equity section of a company’s balance sheet. The balance sheet shows the current equity, but it’s a snapshot of a single point in time. The statement of shareholders’ equity, however, details any changes that have taken place during a given quarter or year.

The top line of the statement shows the beginning balance for each category. The bottom line shows the ending balance. In between, the company details any increases or decreases. These are some of the changes that might appear on the statement of shareholders’ equity:

• Capital raised by issuing common stock, including both the stock’s par value, or face value designated by the company, and additional paid-in capital that shareholders paid to buy the stock over and above the par value.
• Capital raised by issuing preferred stock, a special kind of stock that comes with a greater claim to the company’s earnings than common stock, but no voting rights.
• Retained earnings, profits that the company has brought in but not paid out to shareholders in the form of dividends.
• Treasury stock purchased, or stock shares the company has bought back from shareholders.
• Accumulated other comprehensive income, or the unrealized gains and losses the company has seen in the values of investments that it hasn’t sold.

Treasury stock refers to shares that a corporation has repurchased from its shareholders and now holds. These shares aren’t considered an asset for the company. Instead, they lower the company’s shareholders’ equity - they are included in the calculation of shareholders’ equity as a contra item that reduces the level of equity.

Companies buy back their stock for a variety of reasons. Many companies offer shares to their employees as part of their compensation, so they need shares on hand to pay out. A company might also choose to buy back stock as a means of returning cash to shareholders, or to send a message to the market that it’s confident in its performance.

Because buybacks reduce the number of outstanding shares, they increase the ownership stake that each stockholder has. Buybacks also reduce the total stockholders’ equity - when shares are repurchased and become treasury shares, they are taken out of the level of shareholders’ equity, thereby lowering it.