Become a Financial Modeling & Valuation Analyst (FMVA)®. Enroll today to advance your career!
Login to your new FMVA dashboard today!

Equity

The market value of the assets owned by shareholders after all debts have been repaid

What is Equity?

In finance, equity is the market value of the assets owned by shareholders after all debts have been paid off. In accounting, equity refers to the book value of stockholders’ equity on the balance sheet, which is equal to assets minus liabilities. The term ‘equity’ in finance and accounting comes with the concept of fair and equal treatment to all shareholders of a business on a pro-rata basis.

 

Equity

Image: CFI’s Intro to Corporate Finance Course

 

How Equity Works

Owners of a company (whether public or private) have shares that legally represent their ownership in the company. Each share of the same class has the exact same rights and privileges of all other shares of the same class, and hence where the term equity (meaning equal) comes from.

Companies can issue new shares by selling them to investors in exchange for cash. Companies use the proceeds from the share sale to fund their business, grow operations, hire more people, and make acquisitions. Once the shares have been issued, investors can buy and sell them from each other in the secondary market (how stocks normally trade on an exchange).

 

Types of Equity

There are two types of equity, which are discussed below:

 

#1 Market Value of Equity (Finance)

Financial analysts are typically concerned with the market value of equity, which is the current price or fair value they believe shares on the business are worth. Since finance professionals want to know how much return they can make on an investment, they need to understand how much the investment will cost them, and how much they believe they can sell it for.

 

Market Value Formula

There are various ways to calculate or estimate the market value of equity for a company. Below are several methods that can be used to calculate the value:

  • Number of shares outstanding x market price (this is only for public companies)
  • Net Present Value (NPV) of all future equity cash flows of the businesses
  • Comparable Company Analysis
  • Precedent Transactions

To learn more about how financial analysts value companies, check out CFI’s Business Valuation Fundamentals Course.

 

Example

In the example below from CFI’s Financial Modeling Course about Amazon, you can see how an analyst would build a Discounted Cash Flow (DCF) model to forecast the company’s cash flows into the future and then discount them back to the present. After netting out debts owed, the resulting value is divided by the number of shares outstanding to arrive at the intrinsic value of equity per share.

 

Amazon Cash Flow

 

#2 Book Value of Equity (Accounting)

Accountants are concerned with recording and reporting the financial position of a company, and therefore focus on calculating the book value of equity. In order for the balance sheet to balance, the formula Equity = Assets – Liabilities must be true.

 

Book Value Formula

There are various ways to calculate or calculate the book value of equity for a company. Below are several methods that can be used to calculate the value:

  • Assets – Liabilities
  • Share Capital + Retained Earnings
  • Share Capital + Contributed Surplus + Cumulative Net Earnings – Cumulative Dividends

To learn more about financial statements, check out CFI’s Accounting Courses.

 

Example

Below is a screenshot of Amazon’s 2017 balance sheet which shows a breakdown of the book value of its stockholders’ equity. As you can see in the image, in 2017, the company reported total stockholders’ equity of $27.7 billion.

 

Amazon - Example

 

Market Value vs. Book Value (Future vs. Past)

The main difference between market value vs. book value is that market value is forward-looking (expectations about the future), and book value is backward-looking (recording a history of what happened in the past).

Finance professionals are typically concerned with forecasting or estimating how a company will perform in the future, and hence the focus on what’s going to happen. Accounts, on the other hand, are focused on providing a detailed and accurate picture of what has actually happened, and hence the focus on the past.

 

Price/Book Ratio

Since one is forward-looking and the other is backward-looking, there may be a large discrepancy between market value and book value. It is not necessarily a “good” or “bad” thing if the two values are similar or different.

In order to assess how large the gap is between the market value and book value of a company’s equity, analysts will often use the Price-to-Book (P/B) ratio.

 

Additional Resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:

  • Common Stock
  • Discounted Cash Flow (DCF) Guide
  • Dividend Per Share (DPS)
  • Preferred Shares

Financial Analyst Training

Get world-class financial training with CFI’s online certified financial analyst training program!

Gain the confidence you need to move up the ladder in a high powered corporate finance career path.

 

Learn financial modeling and valuation in Excel the easy way, with step-by-step training.