Also known as shareholders’ equity, stockholders’ equity represents the amount of financing a company has received by selling stocks. Stockholders’ equity is calculated by subtracting a company’s total liabilities from its total assets. Stockholders’ equity comes from two primary sources. The first is the money paid by investors to purchase stocks, and the second is retained earnings that a company is able to amass over time.
Issuing new stockEach share of a company’s stock represents an ownership percentage in that company. Companies typically start out with a specified number of shares they are allowed to issue under their articles of incorporation. These are known as authorized shares. Companies will often start out by issuing some, but not all, of their authorized shares so that the remaining shares are available to help raise capital in the future. When new stock is issued and a company takes in revenue from the sale of that stock, that revenue becomes an asset. Since stockholders’ equity is measured as the difference between assets and liabilities, an increase in assets can also increase stockholders’ equity.
Stock splitsWhile issuing new stock can increase stockholders’ equity, stock splits do not have the same impact. A stock split is a strategic business decision for a company to increase its shares outstanding by issuing additional shares. Companies tend to split their stock when prices climb too high to attract investors.
If a company enacts a 2-for-1 stock split, shareholders will receive an additional share of stock for each one already held. If a company has 40 million shares outstanding and does a 2-for-1 split, it will have a total of 80 million shares after the split, but the value of each share will be cut in half. Since a stock split does not bring in additional revenue for a company, it does not increase stockholders’ equity. Let’s say an investor holds 10 shares of a company’s stock at a value of $10 each, for a total of $100 in stockholder equity. If that same investor later holds 20 shares at $5 each after a stock split, his stockholder equity is still $100.
More isn’t always betterWhile issuing new shares of stock may seem like a good idea in theory, it can sometimes have a negative impact on shareholders. When a company issues additional shares, it can cause its existing shares to become diluted. If the total number of shares outstanding increases, each existing stockholder’s individual ownership share of the company will become smaller, thus making each share of stock worth less.
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