Shareholder equity displays the net worth of a corporation. Shareholder equity also identifies the amount of money the company has received from the sale of its stock. Shareholder equity could be a combination of common and preferred stock, if both types were sold. Legally, shareholder equity equals the claim of all stockholders on the assets of the corporation. Other names for shareholder equity are stockholder's equity, net worth, or share capital.
Calculating shareholder equity for accounting, finance and investment purposes is simple. Add total corporate assets and subtract total liabilities. For example, a company with $200,000 in assets and $175,000 in liabilities has $25,000 in shareholder equity. It doesn't matter how many shares are outstanding. There could be 1,000 shares or 100,000 shares owned by investors. The shareholder equity in this example is $25,000 regardless of the number of shares issued or the number of stockholders.
Where Does It Come From?
There are two typical components of shareholder equity. One is cash from investors who buy stock in the corporation. The amount of investment dollars is called share capital. The second component is called retained earnings. These are accumulated company profits since the business started. The net retained earnings equals all profits minus corporation dividends paid to shareholders. The combination of share capital and retained earnings equals shareholder equity.
Stockholders' Claim on Assets
Although at first potentially confusing, this legal concept is easy to understand. If you own stock in a company that is liquidated, shareholder equity is what's left for stockholders after all business creditors and debts are paid. For example, a corporation with $200,000 in assets and $175,000 in liabilities would, on paper, have $25,000 cash to give to stockholders after all assets were sold and all debts paid in full.
Current and Future Stock Price
Shareholder equity may influence a company's stock price, but it indicates value more than the cost to buy shares. For example, a company with high shareholder equity may also have a strong current stock price, but the company is losing market share to a competitor, making the future appear bleak. Conversely, a company with low shareholder equity has recently offered a superior product, cornering their market. This company's stock price may have strong increases in the future, while the former organization's stock price may tumble, generating investor losses.
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