Looking at Company Financial Statements and Ratios: Shareholder’s Equity

You’ve made the decision to invest, and are thinking about buying individual stocks? Start with understanding the company you want to invest in. A good first step to look at the company’s financial statements (or at least the company profiles on Yahoo! Finance and Morningstar). This series “Looking at Company Financial Statements and Ratios” tries to break down some of the things you should look at to help understand how the company is doing and whether it is priced fairly. Last time, we looked at income statement basics. This week, we’re going to look at the statement of shareholder’s equity.

What is Shareholder’s Equity?

Let’s go back to the basic balance sheet equation for a minute.

Assets (a company’s resources)

Minus Liabilities (a company’s obligations)

Equals Shareholder’s Equity.

So Shareholder’s Equity (or Stockholder’s Equity, or Net Worth) is the book value left in the business after all obligations have been paid. In other words, it’s the book value of the company for all of its owners.

There are two basic parts of shareholder’s equity:

  • the amount of value that was initially invested in the company by shareholders

    • Preferred Stock-Preferred Stock owners have a higher call on company resources than common stock holders in cases of liquidation, and may have guaranteed dividends or get dividends when common stockholders do not. Preferred stock owners generally don’t have voting rights. Not every company has preferred stock.
    • Common Stock-The par value of company stock paid by the initial purchaser to the company in exchange for ownership. Common stock owners have voting rights.
    • Additional Paid In Capital-The amount to the par value the original stock purchaser paid to the company over par value.
  • the amount of value that has accrued through business performance

    • Retained Earnings-the value accrued from business activities over time, minus what the company paid in dividends.
    • Other Comprehensive Income (OCI) adjustments-the value accrued from certain financial activities that are not usually included as income, such as unrealized gains and losses of investments.

In addition, the shareholder’s equity may also include treasury stock (the value of stock the company has repurchased from shareholders), minority interest (the equity of the company owned by a significant but noncontrolling investor. This can show up as either equity or a liability), and other equity.

What is the Statement of Shareholder’s Equity?

Shareholder’s Equity can change due to investment, retained earnings, dividends, OCI adjustments, and various other things. Some of these changes are shown on the income statement, some on the statement of cash flows, and others only in the notes to the financial statement. To track all of the changes from the beginning to the end of an accounting period, companies use the Statement of Shareholder’s Equity. It’s a quick and easy way to see all of these changes in one place.

The Statement of Shareholder’s Equity is set up on a grid. Each column corresponds to a segment of equity shown on the balance sheet, including total equity. If it’s shown on the balance sheet as equity, it should be a column on the statement. Each row shows a change affecting one or more segment of equity. It will also show how that change affects the balance of total equity. Here’s a simplified example:

Statement of Shareholder's Equity

Not every change takes place in every year. While any equity entry from the balance sheet should have a corresponding column, the rows contain only the beginning and ending balances and the activities that actually change the balances. If there isn’t a treasury stock repurchase in a given year, there’s no reason to show an entry for it on the Statement of Shareholder’s Equity. If there are no changes to a segment of equity, all you will see is beginning and ending numbers.

Why Should You Care?

Equity in a company is complex, and book value is affected by many different factors including income, dividends, and investments. The Statement of Shareholder’s Equity is pulling together data from several different areas of the financial statements. The equity statement shows you what is happening to the investor’s value in the company. Is the book value of an individual share being watered down due to sales of additional stock? Is it being boosted by stock repurchases? How does the company’s total dividends compare to net income? Are there a lot of unrealized gains or losses affecting book value?  If you want to know how well a company looks after the interests of its investors, the Statement of Shareholder’s Equity is a good place to start.

Image courtesy of Gualberto107 at FreeDigitalPhotos.net

This article is for information purposes only.

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