When you're looking at a balance sheet, the stockholder's equity, commonly referred to as the shareholder's equity section, reflects the difference between the company's assets and its liabilities: the company's net worth. Items that impact stockholder's equity include net income, dividend payments, retained earnings and Treasury stock. A high stockholder's equity balance in comparison to such items as debt is a positive sign for investors.
Stockholder's equity represents the amount of the company that is financed by common and preferred stock. Preferred stockholders receive dividends in most cases before common stockholders, but do not have the right to vote. There are two formulas for stockholder's equity: assets minus liabilities or stock capital plus retained earnings less treasury stock. Treasury stock comprises share repurchases available for resale or retirement by the company.
Issuing additional shares of common or preferred stock affects stockholder's equity. Common stock have a par value, which is the nominal value determined by the company to be its minimum price. The par value has no relation to the market value of the stock. For example, the company may set a par value of $0.01 per share even though its stock is trading at $25 per share. In addition, you may come across the line item "paid-in-capital in excess of par value" or "additional paid-in capital." This reflects the amount of above-par common shares the company issued.
Net Income and Dividends
Net income is the profit a company earns after paying all expenses and income taxes. A company has two choices of how to use its net income: It can reinvest the money into the business or distribute a portion of it to stockholders in the form of a dividend. When a company issues a dividend, this reduces stockholder's equity. The portion of net income the company keeps in its coffers shows up in the shareholder's equity section of the balance sheet in an account labeled "retained earnings." The figure is the sum of the beginning retained earnings balance and net income minus the cost of the dividends.
Companies commonly repurchase their own stock. This is a boon for shareholders since it reduces the shares outstanding, which increases earnings per share since the same amount of profit spreads across fewer shares. If the company retires the stock by making them Treasury Stock, shareholder equity is reduced. The shareholder's equity section of the balance sheet subtracts treasury stock to derive total shareholder's equity. Treasury stock have no voting rights and receive no dividends, which is why they should not be included in any outstanding share calculations.