What is Equity?

Equity, also called shareholders’ equity or stakeholder equity, gives the holder proportional rights to the remaining cash flows after all debts have been paid. The value of equity depends on your perspective and has both a historical value and an implied value.

Book Value of Equity

The historical, or book value of equity, is the accounting estimation of the value of equity. The book value of equity is located on the balance sheet of a company’s financial statements after subtracting all of the liabilities from the assets.

\[Equity = Assets - Liabilities\]

From a valuation perspective, it does not consider the bright future of some companies and the bleak future of others.

Market Value of Equity

The implied value of equity, also known as the market value of equity, is the hypothetical amount an investor would need to pay today to acquire all of the public equity.

\[Equity = MarketPrice * Shares\]

The market price considers the future value of a company’s equity through the buying and selling of its shares in anticipation of the company’s future cash flows. To determine the market value of equity, multiple it’s current share price by the outstanding shares. Both numbers are easily found on Yahoo Finance.

In Practice

We use both the historical and implied values of equity in valuation. The book value of equity is a backward-looking number used to determine the return on past equity investments. The market value of equity is a forward-looking number that also considers anticipated future returns, and we use it in various calculations such as the cost of equity.

leo

Leo Smigel

Based in Pittsburgh, Analyzing Alpha is a blog by Leo Smigel exploring what works in the markets.