What is equity? (in relationship to stocks)

Introduction
Equity is a term that depends greatly on the topic you are considering. In general equity is what assets you are entitled to after all debts that are attached to that asset have been paid off. An example would be a car that has been paid in full. The car is considered the owner's equity since the owner can sell the car and gain money. When an individual owns something that he has full rights to sell and keep the money from the sale, that asset is one of the owner's equities.

Equity in Relationship to Stocks
Because stocks are considered as partial ownership of a company, they are part of an investor's equity. When you buy stocks you expect to gain equity from the purchase sometime down the road. The more money you make from a sale of stock the more equity that stock has brought you. Equity is also gained in the form of acquiring assets in the case of dissolution or being paid dividends. Consider also that it is possible for an investor to have negative equity.

Balance Sheet
For companies, equity is measured on a balance sheet. As a private investor you are not required to publicly announce your yearly earnings in the form of a financial report. However, understanding how a company calculates equity, can be helpful in calculating personal equity.
Equity is calculated with the following equation:

Equity = Total Assets - Total Liabilities

In relationship to stocks, assets include stocks that have appreciated in value and can be sold for a price higher than they were purchased for. Total liabilities refer to stocks that have done poorly and have dipped down below the value of the original purchase price. You have positive equity if the number of your total assets minus your total liabilities is positive. Conversely, you will have negative equity if your liabilities out number your assets.

Shareholders'/Stockholders' Equity
Stockholders' equity is a term used to refer to the value of a company. Multiplying the number of shares and the amount those shares are worth gives the book value of the company. There are two sources of stockholders' equity.

1. Original money invested through stocks (usually the IPO = Initial Public Offering) and any other subsequent investments


2. Earnings that the company is able to retain through successful operations (a.k.a. monetary increase from year to year.)

Negative Equity
The risk of attaining negative equity is what all investors want to avoid. Negative equity happens when the value of the stock falls below the price it was purchased for. Negative equity outside of the stock world is often referred to when the asset being purchased falls below the value of the loan issued. Whether it is stocks or any other asset, negative equity is when you have to pay more for an asset than it is worth. You are loosing money on your investment if you cannot keep your total assets amount higher than the amount of your total liabilities.

Conclusion
Equity in relationship to stocks is the whole reason for investing. If you follow no other rule but to make sure that you always have positive equity, you will make money in the stock market. A good investor will know when his investment is turning to the negative side and will sell before he looses too much of the equity that he has earned. Still, many investors are willing to risk some equity in the hopes of a big turn-around and a bigger pay-off. Whatever your investing strategy, realize that gaining and retaining equity is what investing in stocks is all about.