Equity

Equity (also known as 'stock' or 'shares') is your slice of the ownership pie in a company. Imagine a company is a giant pizza. If you own a share of its equity, you own one of the slices. When you buy equity, you aren't just buying a fluctuating ticker symbol on a screen; you are becoming a part-owner of a real business, with its factories, brands, and people. The total value of this ownership is what’s left over after all the company's debts have been paid off. This simple but powerful idea is captured in the foundational accounting equation: Assets (what a company owns) - Liabilities (what a company owes) = Equity (what the owners have). As an equity holder, you have a claim on the company's future profits and assets. This means if the business does well, the value of your slice of the pie can grow. But if it goes bust, you’re last in line to get paid, and your slice might shrink to nothing.

Companies need money to grow—to build new factories, hire brilliant engineers, or launch marketing campaigns. One of the primary ways they raise this money is by selling off pieces of ownership, or equity. When a private company first offers its shares to the general public, it's called an Initial Public Offering (IPO). This is a major event where the company “goes public.” After the IPO, these shares become available for everyday investors to buy and sell on a stock exchange, such as the New York Stock Exchange (NYSE) or NASDAQ. These exchanges are simply organized markets where the forces of supply and demand meet. Millions of buy and sell orders from investors around the world determine the daily price of a company's stock, which can sometimes feel chaotic.

For a value investing practitioner, owning equity is about participating in the long-term success of a great business that you bought at a reasonable price. It's not about gambling on short-term price wiggles. There are two primary ways you profit from this ownership stake.

• Capital Gains: This is the most common way people think of making money with stocks. You buy a share for $50, and because the underlying business performs well over the years—growing its sales and profits—other investors recognize its value, and the market price of your share rises to $100. The $50 difference is your capital gain.
• Dividends: Think of this as your direct share of the profits. A stable, profitable company might decide to distribute some of its earnings back to its owners (the shareholders). If a company declares a $1 per share annual dividend and you own 100 shares, you'll receive a check for $100, regardless of what the stock price did that day.

The legendary investor Benjamin Graham taught that you should view the stock market as a moody business partner he called Mr. Market. Some days, Mr. Market is euphoric and will offer to buy your shares at a ridiculously high price. On other days, he's panicked and will offer to sell you his shares for far less than they're truly worth. A wise investor ignores the mood swings and instead focuses on the underlying business. Your job is to calculate a company's intrinsic value—what it's really worth—and only buy when Mr. Market offers you a significant discount. You are buying a business, not just renting a stock.

To truly understand the business you're buying, you need to look at its financial statements. The balance sheet provides a snapshot of a company's financial health, and a key section is Shareholder Equity. It typically consists of:

• Common Stock: This is the standard type of equity that gives you voting rights and a claim on profits.
• Preferred Stock: A less common, hybrid type of ownership that often pays a fixed dividend but usually doesn't come with voting rights. Owners of Preferred Stock get paid before common stockholders if the company is liquidated.
• Retained Earnings: This is a goldmine for value investors. Retained Earnings are the cumulative profits that the company has reinvested back into the business over the years instead of paying them out as dividends. A company with a long history of growing its retained earnings is often a sign of a wonderful business that can skillfully reinvest capital to generate even more profit in the future.

A useful starting metric derived from this section is Book Value, which is the total Shareholder Equity divided by the number of shares. It tells you the net asset value of the company on paper.

Ownership comes with responsibility and risk. Equity is no different.

• Volatility: Share prices can be extremely volatile in the short term, driven by news, sentiment, and Mr. Market's mood swings.
• Loss of Capital: Unlike a bond holder, who is a lender to the company, an equity holder is an owner. If the company goes bankrupt, lenders and bondholders get paid first from any remaining assets. Often, by the time it's the equity holders' turn, there's nothing left. Your investment could go to zero.
• Dilution: When a company issues a large number of new shares (for example, to fund an acquisition or pay employees), it can cause dilution. This means your original slice of the ownership pie gets smaller, reducing your claim on future profits.