What is equity?

In essence, equity represents the shareholders' ownership of a company. The ownership ratio determines a shareholder's power in the company's decision-making and how many dividends they can get. In the balance sheet of a listed company, the equity of all shareholders is combined and presented as shareholders' equity. The formula is shareholders' equity = total assets - total liabilities. 

Benefits of Equity

• Right to receive dividends

• The fundamental right of shareholders is to receive dividends according to their stake in a company

• Voting power

• Voting power refers to shareholders' rights in decision-making on significant issues of a company; at the same time, shareholders also have the right to elect board members in a joint-stock company

• Entitlement to have a distribution of liquidated assets

• Shareholders are entitled to a distribution when a company is liquidated, but the premise is that the company's assets are more than its liabilities

Equity can be defined as the amount of money the owner of an asset would be paid after selling it and any debts associated with the asset were paid off. For example, if you own a home that's worth $200,000 and you have a mortgage of $50,000, the equity in the home would be worth $150,000.

In investing terms, equity investors purchase stock for a share of ownership in companies with the expectation that the stock may earn dividends or can be resold with a capital gain. If the investment were to rise in value, the equity they could get for selling it potentially increases.

Equity investors purchase stock for a share of ownership in companies with the expectation that the stock may earn dividends or can be resold with a capital gain.

What are the different kinds of equity?

Shareholder equity – When an investor invests in a company, they can claim to own a very small piece of the company. This is known as shareholder equity. As an equity shareholder, you are entitled to a share of the company profits.

Home equity – This can be defined as the current market value less any outstanding debt. This can be calculated by subtracting the mortgage and other debt owed against the home from the total value of the home.

Private equity – This is the evaluation of a company that is not publicly traded. This applies where stated equity on a private company's balance sheet is what remains after subtracting liabilities from assets.

Brand equity – This is made up of intangible assets such as a company's reputation and brand identity. A company's brand can create value through consistently effective marketing. A loyal customer base can also contribute to brand equity.

The difference between stocks and equity

While stocks and equity are sometimes used interchangeably, as an investor, it's a good idea to understand the difference between these terms. When a listing of shares takes place via an initial public offering (IPO) or new issue, a certain amount of equity, or ownership, is assigned for investors to purchase in the form of stocks. 

Stocks are market-traded shares of a company and are sometimes called 'equities' — this is not to be confused with 'equity' which refers to ownership in a company.

How is equity used by investors?

Equity is simply the value of an investor's stake in a company. It is represented by the value of shares an investor owns. Stock ownership gives shareholders access to potential capital gains and dividends.

Other terms like shareholders’ equity, book value, and net asset value are often used to describe equity. While the specific meanings of these terms may differ slightly, they are generally used to determine if the company receives funding from lenders or investors.

What is return on equity?

Let's say an investor owns a certain amount of stock in a company. The investor's Return on Equity (ROE) is the rate of return they receive on their shares. This is calculated as a ratio and can be used to measure the ability of a company to generate returns. Firms with higher ROEs are generally preferred by investors who may use it to compare stocks within the same sector. This is because profit levels can vary across different sectors.

On a final note

Equity is often used in many ratios as part of fundamental analysis and as a benchmark when assessing the purchase price of a stock. Equity can be found on a firm's balance sheet and is an important data point that can help analysts assess a company's financial health. As a concept, equity is of great importance to investors as it helps them to understand the value of their investments and to build long-term financial stability.

An equity investment is money that is invested in a company by purchasing shares of that company in the stock market, these shares are typically traded on a stock exchange.

Why should I consider equities?

Equity investors purchase shares of a company with the expectation that they’ll rise in value in the form of capital gains, and/or generate capital dividends. If an equity investment rises in value, the investor would receive the monetary difference if they sold their shares, or if the company's assets are liquidated and all its obligations are met. Equities can strengthen a portfolio’s asset allocation by adding diversification.

What are the potential benefits of equity investments?

 The main benefit from an equity investment is the possibility to increase the value of the principal amount invested. This comes in the form of capital gains and dividends. An equity fund offers investors a diversified investment option typically for a minimum initial investment amount. If an investor wanted to achieve the same level of diversification as an equity fund, it would require much more – and much more manual – capital investment.

Key Takeaways

• Equity refers to various rights and benefits shareholders enjoy in a company.

• Equity is also called shareholders' equity, which is calculated by subtracting total liabilities from total assets.

• Equity represents a wide range of rights, such as the entitlement to receive dividends, vote, and receive a distribution in liquidation.

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