An Introduction to the Balance Sheet: Equity

schoolbusThis article is the sixth lesson in the ModernGraham Academy beginner’s course, An Introduction the the Balance Sheet.  The ModernGraham Academy is a place to learn about the basics of investing, with an emphasis on the ModernGraham approach.

This course will be a detailed look at the balance sheet, starting with a basic overview, then a look at each part of the statement individually, and finishing up with a review and some final comments.

What is Equity?

Equity is the third section of the balance sheet, and is equal to the total assets minus the total liabilities.  One way of looking at equity is to consider it as a theoretical value of the company; however, it is not an accurate reflection of the current market value because the value of the assets may be reduced by depreciation based on certain accounting standards rather than having the value of the asset on the balance sheet accurately portray the exact market value at a given moment in time.

There are three main components of the equity section of the balance sheet:

  • Capital – This section reflects the amount of money actually contributed to the company by investors.
  • Treasury Shares – A company may buy back some of the shares it has issued.  When it does, these shares are subtracted from the amount of equity.
  • Retained Earnings – If a company does not distribute its earnings via dividends, then money that is retained by the company or reinvested by the company is considered to be retained earnings.

Homework

This week, please discuss the following question with a one paragraph response in a comment to this post:  Would you rather see a company pay out its earnings in dividends, or retain the earnings?  Why?

An Introduction to the Balance Sheet Course Overview

Photo provided by iBoy_Daniel


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3 responses to “An Introduction to the Balance Sheet: Equity”

  1. Matthew Avatar
    Matthew

    Hi Benjamin,

    First time post here, been following your blog for a few weeks now.

    At this point in my investing career (23 years old, still getting an education), I’d much rather invest in a company that retains its earnings. I feel they could use the money much more effectively than I could use a dividend payout, and I’d rather see the capital appreciation (if that’s the correct term) of properly reinvested earnings increase the value of my company over time. I’ll look for dividend payers later on.

    1. Benjamin Clark Avatar

      Thanks for the comment.

      I am a big fan of dividends because they generate income on your investment. When you are receiving dividends, you are receiving a return. Without dividends, you are left to speculate that the market will improve the value of your investment.

      1. kej210 Avatar
        kej210

        I’ve read a lot of great things about dividends (also in the learning stage of investing at 25 years old) but I’ve also read a lot about how much of a headache created by the taxes surrounding dividends.

        I’m wondering if you could comment on the tax side of dividends and how do best deal with it (investing within an ROTH IRA for example).

        Thank you

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