Understanding equity, and what is actually yours
The answer
Equity is what would be left for shareholders if every asset were turned into its recorded value and every liability were paid. It is the last claim in the queue, which is why it is also the most valuable one when a business works.
Divided by the number of shares, it is called book value per share. It is not what your shares are worth.
Why this costs you money
Most investors treat equity as one number. It is 2 very different things added together, and the split is the information.
The first part is money shareholders put in. Share capital, and the premium they paid above the face value of the shares. This money came from outside. Somebody wrote a cheque.
The second part is money the company earned and kept. Retained earnings. Every rupee of profit since the company was founded, minus every rupee paid out as dividends or spent on buying back shares.
Two companies can both report equity of ₹8,000 crore. In the first, ₹7,400 crore is retained earnings: that company generated ₹7,400 crore of profit over its life and kept it. In the second, ₹7,400 crore is share premium from repeated share issues and retained earnings are ₹600 crore: that company raised money from investors over and over, and earned very little.
They look identical on any screener. They are not the same business.
Here is the cost. When a company keeps issuing new shares, your ownership percentage falls every time. The equity number grows and your slice of it shrinks. A shareholder who tracks total equity and never tracks share count can watch a company "grow" for 8 years while their own claim gets smaller.
The second cost is that equity is a residual. It is assets minus liabilities. If the assets are overstated by ₹5,000 crore, the equity is overstated by exactly ₹5,000 crore, because there is nowhere else for the error to go. Equity absorbs every mistake and every lie in the rest of the balance sheet.
How it works
Under Ind AS and Schedule III, Indian balance sheets show equity in 2 lines: Equity share capital, and Other equity. The detail is in a note. Under US GAAP the components are usually shown on the face of the balance sheet.
The components are the same in both countries, with different names.
Share capital is the number of shares issued, multiplied by the face value printed on them. Face value in India is typically ₹10, ₹5, ₹2 or ₹1, and it is an accounting convention with no economic meaning. In the United States it is called par value and is often $0.01 or less.
Securities premium, called additional paid-in capital in the United States, is the amount paid above face value when shares were issued. If a company issued shares at ₹500 with a face value of ₹10, then ₹10 goes to share capital and ₹490 goes to securities premium, per share. This is the bulk of the money shareholders actually contributed.
Retained earnings is accumulated profit not paid out. In older Indian reports it may be called "surplus in the statement of profit and loss". This line goes up by profit after tax each year and down by dividends.
Other reserves. Three are worth knowing.
- Revaluation reserve. Created when property, plant or equipment is revalued upward under Ind AS 16. No money entered the company. It does not exist in American accounts, because US GAAP does not permit the revaluation.
- Capital redemption reserve. Created when shares are bought back, to protect creditors. A legal restriction, not spendable money.
- Other comprehensive income, or OCI. Gains and losses recorded in equity without passing through profit: currency translation of foreign subsidiaries, some investment revaluations, and actuarial gains and losses on pension schemes.
Treasury shares, in the United States, are shares the company has bought back and holds. They appear as a negative number inside equity.
Non-controlling interest, in consolidated accounts, is the portion of a subsidiary's equity owned by somebody other than the parent. It sits inside total equity and it is not yours.
Book value per share
Equity attributable to shareholders ÷ number of shares outstanding = book value per share
In a consolidated balance sheet, use equity excluding non-controlling interest. That is the part that belongs to the company's own shareholders.
Book value per share is a record of money contributed and money retained, adjusted by accounting rules. It is not a valuation. For a software company with no factories it will be very low and the business may be superb. For a steel company it will be high and the business may be poor. The one place it carries real weight is banks and lenders, where the assets genuinely are financial claims measured in money and regulators set capital requirements against it.
What it tells you, and what it does not
Equity tells you how much of the company's funding came from owners rather than lenders, and — through the split — whether that money was earned or raised.
It does not tell you what the shares are worth. Companies routinely trade at 6 times book value or at half of it. Both can be correct.
It does not tell you the company has that money. Equity is not a bank account. Retained earnings of ₹7,400 crore does not mean ₹7,400 crore of cash sitting anywhere. That profit was earned over decades and spent on factories, acquisitions and working capital. The cash line on the balance sheet is the only place cash is recorded.
It is not an independent measurement. It is a subtraction. Every judgement made on the asset side and the liability side lands here.
The decision rule
Split equity into what was put in and what was earned, and track share count beside it.
If equity is growing and retained earnings are the reason, the company is funding itself from its own profits. If equity is growing and share capital and premium are the reason, existing shareholders are being diluted — unless the new money is buying assets that raise profit per share, which you can only confirm by checking earnings per share 2 years later, not by reading the balance sheet.
And if equity grew mainly through a revaluation reserve, nothing happened at all.
Try this now
Fifteen minutes, on 1 holding. This is the exercise that tells you whether the company you own has been earning its growth or buying it with your ownership percentage.
- Open the latest annual report for 1 holding. Find the balance sheet and write down equity share capital and other equity, or in an American filing, the full equity section.
- Go to the note that breaks down other equity. In an Indian report it is usually called "Other equity" and is a grid with a column for each reserve. In a 10-K, use the Statement of Stockholders' Equity.
- Write down 3 figures: securities premium (additional paid-in capital in the United States), retained earnings, and anything sitting in a revaluation reserve.
- Add share capital and securities premium. That is roughly the money shareholders put in. Express it as a percentage of total equity.
- Express retained earnings as a percentage of total equity too.
- Now find the number of shares outstanding, on the same balance sheet or in the share capital note. Compare it to the figure 3 years ago, which is in the older annual report or in the same note's reconciliation.
- Calculate book value per share for both years: equity excluding non-controlling interest, divided by shares outstanding.
What you should see. For a mature, self-funding company, retained earnings will be the large majority of equity, often 70% or more, and the share count will be almost unchanged over 3 years. That combination means the company funded its growth from its own profits and did not ask you to fund it.
If securities premium dominates and retained earnings are small, the company has been financed by repeated share issues. That is normal for a young or loss-making company. It is a serious question for a 20-year-old one.
If the share count has risen more than a few percent in 3 years, find out why. Employee stock options, a preferential issue, a qualified institutional placement and a merger are all normal reasons. What matters is whether book value per share and earnings per share rose as well. If they fell, the money raised has not yet earned its keep.
Three real cases
1. Satyam Computer Services, 7 January 2009 (India) — equity absorbed the entire fiction For years Satyam reported profits that flowed into reserves, building an equity figure that looked like the record of a successful business. When chairman B. Ramalinga Raju admitted on 7 January 2009 that the accounts had been manipulated by roughly ₹7,000 crore, including non-existent cash, the equity figure was revealed as the accumulated total of those fictions. Every overstated asset had a matching overstated reserve, because double-entry bookkeeping requires it. Satyam's book value per share had been published, audited and meaningless.
2. Enron Corporation, 16 October 2001 (United States) — equity restated downward by $1.2 billion in one announcement Enron's restatement on 16 October 2001 cut reported earnings for 1997 to 2000 by $613 million, increased liabilities by $628 million, and reduced shareholders' equity by $1.2 billion, about 10% of reported equity. That announcement began the collapse, and the company filed for Chapter 11 on 2 December 2001. Note the mechanism: equity did not fall because the company lost money that quarter. It fell because previously reported assets and liabilities were corrected, and equity absorbs corrections.
3. Yes Bank, March 2020 (India) — equity is the first thing to disappear The Reserve Bank of India placed Yes Bank under a moratorium on 5 March 2020, and a reconstruction scheme followed with an investment led by the State Bank of India. Accumulated losses had eroded the bank's equity. Under the scheme, Additional Tier 1 bonds with a face value of ₹8,415 crore were written down to zero. Equity is the last claim in the queue. In good years that is why it is worth the most. In a failure it is why it is worth nothing first.
The question that resolves it
A novice looks at equity and asks: how much is the company worth?
An expert looks at the same lines and asks: how much of this did shareholders put in, how much did the business earn, and how many shares is it divided between now?
The first question has no answer on that page. The second one has 3 answers, all of them printed, all of them useful, and together they describe how the company has been funded for its entire life.
What would make this wrong
If book value were a good guide to value, then buying companies below book value would be reliably profitable. It is not, and the reason is instructive: companies trade below book value most often when the market believes the assets are worth less than the balance sheet says. Frequently the market is correct.
Three honest limits.
Book value is nearly useless for asset-light businesses. A consulting firm, a software company or a media business may have almost no equity and enormous earning power.
Buybacks can drive equity negative, legitimately. A very profitable company that returns more than its retained earnings to shareholders through buybacks can report negative equity. That is a capital allocation choice, not distress. Read the cash flow statement to tell it apart from negative equity caused by losses. They look the same on the balance sheet and they are opposites.
Reserves are not all available. Some are legally restricted from distribution, such as the capital redemption reserve. Some represent no money at all, such as the revaluation reserve. Treating total equity as a pool the company could pay out is wrong on both counts.
In India
Schedule III presents equity as 2 lines on the face — equity share capital and other equity — with the detail in a note. Under Ind AS, the Statement of Changes in Equity is a required statement, showing every movement during the year.
Four Indian features.
Securities premium is restricted. Under Section 52 of the Companies Act 2013, the securities premium account can only be used for specified purposes, including issuing bonus shares and buying back shares. It is not available for dividends.
A bonus issue moves money within equity. The company converts reserves into share capital and issues free shares. Total equity is unchanged. Your ownership percentage is unchanged. Book value per share falls in exact proportion to the increase in share count. Nothing has been given to anybody.
Promoter holding is disclosed separately in the shareholding pattern filed with the exchanges every quarter, along with the percentage of promoter shares pledged to lenders. There is no direct American equivalent for most companies, because most American companies have no controlling family.
Revaluation reserve exists. Because Ind AS 16 permits upward revaluation, an Indian company's equity can grow without profit and without a share issue.
In the United States
American balance sheets typically show the equity components on the face: preferred stock, common stock at par, additional paid-in capital, retained earnings, accumulated other comprehensive income, and treasury stock as a negative.
Four American features.
Treasury stock. American companies buy back shares and often hold them rather than cancelling them. They sit as a negative number inside equity and can be reissued later, typically to satisfy employee stock plans. Indian companies must extinguish shares bought back; there is no treasury stock in Indian buybacks. Buybacks are large and routine. Many large American companies return more cash through buybacks than dividends. Over many years this can reduce equity substantially, and even below zero, without the business weakening.
The Statement of Stockholders' Equity is laid out as a grid: one row per event, one column per component. It is the clearest presentation of equity movements in either country and takes about 3 minutes to read.
Share-based compensation is a large equity item in technology companies. Shares issued to employees increase share count and dilute existing holders. Reading profit and not share count misses half of it.
Where they differ, and what that tells you
Two divergences are real and they point in opposite directions.
In the United States, a long history of buybacks can produce negative equity at an excellent company. A rule like "avoid companies with low equity" would exclude some of the best businesses in the market. The correct step is to look at what reduced the equity: buybacks, or losses.
In India, upward revaluation under Ind AS 16 can raise equity without any money entering the company. A rule like "rising equity means the company is strengthening" would count a change of opinion about land prices as performance. The correct step is to look at what raised the equity: profit, a share issue, or a revaluation.
The second divergence is about who owns the rest of it. Indian listed companies commonly have a promoter group holding 40% to 75%. American companies are more often widely held, with index funds as the largest holders. In India, a decision that reduces your slice — a preferential issue to a related party, a related-party transaction on poor terms — is made by somebody who controls the vote. Indian regulation responds to exactly this, which is why material related-party transactions require approval from shareholders with the related party unable to vote.
What that tells you is which disclosure to read alongside the equity note. In India, read the shareholding pattern and the related party note. In the United States, read the share-based compensation note and the buyback disclosures. The question is the same in both: is my slice getting bigger or smaller?
Carry this
- Split equity into money put in and money earned. The split is the story.
- Retained earnings is not cash. It was spent long ago.
- Track share count beside equity. Growing equity with a growing share count may be no growth at all for you.