Buying shares of stock in publicly traded companies is a primary way to invest. Stock gives the investor "equity," or fractional ownership, in the company. Key considerations for potential investors are the value of the company and its ability to generate profits. "Retained earnings" and "stockholder's equity" are primary measures of value and profitability. These figures, readily available to investors, are interrelated and equally important.
A major goal of public companies is to generate profits, or net income. Net income is the capital remaining after all expenses, taxes and interest on debt are subtracted from the total revenues during the quarterly or annual reporting period. Retained earnings, also known as retained capital, are the portion of net income that management keeps to fund future growth and to pay down company debt. If a company loses money during a reporting period, the loss -- referred to as retained losses -- offsets earnings.
Public companies capitalize or fund themselves by selling stock and debt (bonds), which are liabilities. Stockholder's equity measures the original and subsequent contributions, known as share capital, paid to a company by equity investors in exchange for shares of common and preferred stock, plus the retained earnings of the company. Stockholder's equity is often referred to as the book value, net worth, or the owners’ claim on a corporation. That is because it represents the value of all the shares owned by stockholders in the company.
Potential and current investors of any corporation are most interested in a company's ability to generate profits that would be either distributed to stockholders as dividends or reinvested in the company to fund future growth and potentially increase share value. The figures on retained earnings and stockholder's equity provide insight into management's ability to deliver profits using available assets. Over time, both measurements help investors determine what they can reasonably expect from their investment.
Retained earnings or losses are calculated by adding a company's retained capital from the beginning of the period to the current net income or loss, and then subtracting any current dividend. Stockholder's equity is calculated by adding total share capital and retained earnings or losses, minus all shares retained or repurchased from the public by the company. These shares are referred to as treasury stock. Alternatively, stockholder's equity can be calculated by subtracting a company's total liabilities from its total assets. A company with more liabilities than assets has negative book value, which is referred to as a stockholder's deficit.
The retained earnings and stockholder's equity figures for the current period are reported in the stockholder's equity section of a company's balance sheet. Current retained earnings are calculated on the statement of retained earnings after the completion of the income statement by a company. That figure is transferred to the stockholder's equity portion of the balance sheet. It then is added to the share capital and netted against the treasury stock balance to provide the stockholder's equity balance for the current period.
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