We often hear the question, “how much equity do you have in your home?”  The term “equity” refers to ownership.  If there is a mortgage on the home, the total equity is shared by the borrower and by the lender.  That is, the borrower has an ownership stake and so does the lending institution.

When you buy a share of a company’s common stock, you are buying a share of equity because you are purchasing an ownership interest in that company.  How much is the equity stake worth when you buy?  That is, how much is the share of common stock really worth when you buy it?  You must be able to adequately answer that question before you buy; otherwise, you may overpay for the stock.  Overpaying can lead to painful losses.  Conversely, knowing the approximate worth of a stock and buying it for less than that worth can result in healthy investment gains.

If buying a share of common stock is actually buying a share of equity, it would surely seem logical that I would need to know how much the total equity of the company is today before I try to figure out how much I’m willing to pay for a share of that total pie.  In fact, it is not only logical but also essential if I am to buy a quality stock at a bargain price.

This is where the financial statement called the “balance sheet” comes into the picture.  The total equity of a company is found on the balance sheet in an amount referred to as “Stockholders’ Equity.”  When buying a share of common stock, one is buying a share of Stockholders’ Equity.  Evaluating the balance sheet before buying common stock is the essence of what I consider wise investing.