What Is Stockholders' Equity?

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Contributor, Benzinga
Updated: May 25, 2021

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Stockholders’ equity is an accounting term that can be found on a balance sheet of a publicly traded company. The balance sheet has three major components: assets, liabilities, and equity.

When the company is owned by shareholders, equity is called shareholders’ equity or stockholders’ equity.

To buy assets, a company needs capital. Some of the capital can be borrowed and in that case, accountants book it as liabilities. If the capital is paid in by shareholders or if it is accumulated by the company, it is booked as stockholders’ equity.  

How assets, liabilities, and stockholders’ equity relate

Since assets are funded by liabilities and stockholders’ equity, they have to be equal to their sum. From this rule, we can derive a simple mathematical formula for the stockholders’ equity. The Stockholders’ Equity = Total Assets - Liabilities.

So, if we sell all the assets at their book value and use that money to pay all the liabilities, the rest will belong to stockholders.  You can check out the balance sheet below to see how the imaginary ABC Co.'s shareholders' equity is calculated.

Shareholders' equity equation
Source: Bdc.ca

Stockholders’ equity vs market value

If we multiply the current stock price with the number of issued shares we will get the market value of the company. A decline in a stock price of 10 percent means that the owner of the shares has lost 10 percent of her or his investment.

It doesn’t mean that the company has lost money. The company receives money from investors during a public offering and fluctuations that happen after the offering can’t change that amount. Stockholders’ equity is often called the book value of the stock and some analysts use it to value a company. They divide market value by book value to see how much are traders willing to pay for $1 of the book value of the company.

How we break down stockholders’ equity

We can break down stockholders' equity into the following:

  • Common Stock
  • Preferred Stock
  • Options and warrants
  • Capital surplus or additional paid-in capital
  • Retained earnings
  • Accumulated other comprehensive Income
  • Treasury stock

How capital contributed by investors is put on the books

Issued shares usually have selling price and its par, otherwise known as nominal or face, value. The par value can be very low, so a stock with a selling price of $40 per share can have a par value of $0.01.

If a company is raising capital by issuing common stocks, accountants are going to book in the subcategory of stockholders’ equity, called common stock, the amount that is equal to the multiple of par value per share and a total number of issued shares. Total cash received would be booked in assets under cash and the difference would go to additional paid-in capital.

It is similar for preferred stocks. Its par value is booked under preferred stock and the rest goes to the additional paid-in capital.    

What about the rest of stockholders’ equity?

A profit or a loss that a company makes in an accounting period is booked as retained earnings in stockholders’ equity. This item represents the cumulative earnings of the company after the payment of dividends. The management can decide to retain earnings and use it to fund operations or they can decide to return it to owners as dividends.

Accumulated other comprehensive income represents unrealized gains or losses that are not included in the income statement. Treasury stock has a negative balance and it represents the amount the company pays when it buys back shares from investors.

Final thoughts

Stockholders’ equity represents a book value of the company and it can be used to value shares of the company, but it can often be misleading. We can often see that stocks trade below its book value. During the banking crisis in the U.S., banks were trading significantly below its book value because investors expected impairments of their assets due to bad loans.

These impairments, when booked, reduce stockholders’ equity and the book value of the company. So, it is very important to test the fair value of all assets and liabilities based on the events that have occurred after the company reported earnings, or we can see that happen again in the future.