In a nutshell, shareholder equity is part-ownership of a company. But how does equity work, exactly? And why is it an investment strategy? Find out here.
6 min read
Even if you don’t work in finance, you might have heard of equity — especially if you’re an entrepreneur, digital nomad, or knowledge worker. Not sure what equity is, though? You’ve come to the right place.Equity is vital in European financial markets for raising capital and allowing investors to participate in businesses’ growth and success. In this article, we’ll cover what equity means, how it works, opportunities and strategies to invest in equities, and the legal requirements that come with investing. Let’s start simple: What’s the definition of equity?
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What does equity mean? Equity concepts for European investors
At its core, equity (often called shareholder equity) means ownership in a company — and more specifically, the value of that ownership. It’s shown on the company’s balance sheet and it indicates the company’s financial health for investors.If a company paid off everything it owes and sold all its assets, the remaining money would be the equity distributed to shareholders. If a company was acquired, its equity is the value of its assets minus any liabilities not transferred with the sale, such as debts.When you buy shares in a company, you’re buying a piece of this equity, making you a part-owner of the company.
Is equity the same as debt financing?
No, equity and debt financing aren’t the same thing. Companies use these two distinct methods to raise capital, but each has its own characteristics and implications.Debt financing involves borrowing money that has to be repaid over time with interest. This can be done through loans, bonds, or other forms of credit. Unlike equity, debt financing doesn't affect the company’s ownership.
Finding equity on a company's balance sheet
The balance sheet is a key financial statement typically included in a company's annual or quarterly financial reports. The equity section is usually at the bottom of the balance sheet, after the liabilities section.
How does equity work?
Equity financing allows businesses to raise funds for operations, growth, and development without increasing their debt burden. Equity ownership gives shareholders two major things: the potential for financial gains through dividends and capital appreciation, and the right to vote on corporate decision-making. Therefore, shareholders have a strong financial interest in the company's performance and governance, and shareholder equity is a fundamental metric for many companies.Positive shareholder equity means that a company's assets outweigh its liabilities, indicating financial stability and good financial health. On the other hand, negative equity means that a company's liabilities are larger than its assets, which suggests poor financial health and a risky investment. While shareholder equity alone isn’t a comprehensive measure of financial health, it does provide a strong clue about a company's financial condition.
Equities and voting rights
Shareholder equity typically comes with voting rights in corporate decisions. If stockholders hold a proportionate equity share, they have voting power to influence matters like board member elections or the approval of major corporate actions. This shows the democratic power of equity, granting shareholders a voice in steering the company's direction.
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Not all equities are created equally. Investors and business owners mostly encounter private equity (in private companies) and shareholder equity (or owner's equity, for companies with sole proprietorship). Here's a brief overview of each type:
Private equity is private investment in companies that aren’t listed on public stock exchanges. Private equity firms or individual investors provide capital to private companies in exchange for ownership stakes. Private equity investments can involve buyouts, venture capital, and growth capital.
Shareholder equity (or owner's equity): Shareholder equity, or owner's equity, represents the residual interest in a company's assets after deducting liabilities. It includes common stock, preferred stock, retained earnings, and additional paid-in capital. If you’re interested in equity as a first-time investor, or if you’ve received equity as part of your compensation package, this is probably the type of equity that’s involved. Again, shareholder equity reflects the total value shareholders would theoretically receive if all of a company’s assets were liquidated and all of its debts paid off. It's a key indicator for investors assessing a company's worth.
Now that we've covered equity, how it works, and what types are available, let's examine investment opportunities, strategies, and potential risks.
Equity investment opportunities and strategies
Equity investment offers many opportunities and strategies for investors seeking to grow their wealth over time. Most commonly, there are two approaches:
Growth investing: This strategy identifies companies with strong potential for above-average revenue, earnings, or cash flow growth. It often involves investing in technology, healthcare, and consumer discretionary sectors. Growth investors typically tolerate higher volatility and may pay premium prices for stocks with promising growth prospects.
Value investing: This involves identifying undervalued stocks trading below their intrinsic value. Value investors seek companies temporarily out of favor or overlooked by the market—mature companies with stable cash flow and strong fundamentals that trade at discounted prices due to short-term challenges or market sentiment. Value investors focus on metrics such as price-to-earnings ratio, price-to-book ratio, and dividend yield to identify bargains and build diversified portfolios capable of delivering consistent returns over the long term.
European investors can access equity markets through financial markets, mutual funds, and exchange-traded funds (ETFs). These options provide access to domestic and international stocks, allowing investors to diversify their portfolios and capitalize on global growth opportunities.Investing in individual stocks entails risks, including company-specific factors such as business performance, management decisions, and industry dynamics. On the other hand, equity funds offer portfolio diversification benefits by pooling investors' capital and spreading risk across a portfolio of stocks. Always choose your investments based on your risk profile, long-term goals, and budget!
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European markets' national laws, regulations, and corporate governance codes set the rules for shareholder rights. While the specifics vary across countries, European shareholder rights are generally similar to those in other developed markets, including voting rights, access to information, and the right to receive dividends. There are differences in certain areas, though, such as the level of shareholder activism and dual-class share structures. These factors can impact the degree of shareholder influence and protection.If you’re considering getting into European equity investments, don’t forget to research the tax implications — tax laws vary across countries and can significantly impact the return on your investments. When making investment decisions, make sure to consider capital gains taxes, dividend taxes, and withholding taxes on dividends.
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Disclaimer
These statements do not constitute investment advice relating to any financial instrument. Financial instruments can be subject to high fluctuations in value. A decline in value or a complete loss of the money invested is possible at any time.
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