What is equity and how does it work?

Here, we break down the definition of equity, cover how the term applies in various scenarios and dive deeper into its use in investing. Equity is a valuable trading product for wealth growth and diversification, so learning the basics matters.

What does equity mean? And examples

In essence, equity is the value held in the ownership of something. You can calculate equity by taking the market value of the asset minus any debt associated with it.

Home equity is a simple example. A homeowner’s equity is the value of their home minus any debt associated with it, such as a mortgage. Over time, home equity usually increases because the home’s market value increases while the mortgage value decreases through repayments.

Here’s another simple example. In private business ownership, equity is the amount of money left over after debts are paid off to creditors during liquidation.

What counts as an equity investment

As an investor or potential investor, you will likely be interested in equity trading and investment. Equity investment is a popular form of investment and it involves buying company shares. People often use the terms stocks, shares, and equities interchangeably.

When investors buy shares on the stock market, they become shareholders in that company. In effect, they are buying a share of company ownership. The value of this ownership is shareholder equity.

Shareholder equity represents what would be returned to the investor if the company were liquidated and all its debts paid. You can calculate shareholder equity by referring to a company’s balance sheet. Equity is the total assets minus total liabilities.

Positive and negative equity in finance

Like all types of equity, shareholder equity can be negative or positive. Negative shareholder equity means that the total value of a company’s debts exceeds the value of its assets and this may represent a risky investment. Conversely, positive equity implies that a company is in better health as the value of its assets exceeds its debts.

How investors approach equity

Equity investors buy shares expecting that their value will rise, allowing them to sell at a profit or benefit from dividend payouts. Shareholder equity fluctuates in value when the balance between the company’s assets and debts changes. Equity may increase if the value of the company increases or its debts decrease, and selling at this point would be profitable.

Equity shareholders can earn dividends from their investment, too. Dividends are distributions of earnings to a company’s shareholders, usually quarterly.

Owning equity also gives shareholders the right to vote on various company actions and in elections to the board of directors. These benefits mean that shareholders can help shape the direction of a business.

How businesses make use of equity

Equity in finance is important because it represents both a picture of a company’s financial health and an opportunity for the company to raise capital.

Companies sell equity in their business by listing shares on the stock markets. Usually, a proportion of ownership is presented to the public in the form of stocks or equities, and potential investors are invited to purchase these in the volume they choose.

For companies, equity can be used to raise capital. By selling stocks, companies can purchase assets, make investments in new projects, or fund new operations. This process helps drive the growth of a business and is known as equity financing.

Should equity be part of your strategy?

Equity investment can be part of a diverse portfolio alongside other asset classes like forex and commodities.

Purchasing shares of a company on an exchange can be a wise investment when you have the expectation that the share price will increase in the long term. If your shares increase in value, you can sell them in the future for profit as well as enjoy dividends in the short term. Remember, however, a share price increase is not guaranteed.

Types of equity investment worth exploring

Consider investing in public equities on the stock market. Note that private equity funds are stakes in a private company not listed on the stock exchange, and involve a long-term and high-stakes commitment. Public equities, on the other hand, can be bought on the stock market by anyone with a brokerage account and do not lock you into a long-term commitment.

How to expand your knowledge of equities and other markets

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