Common equity represents the partial ownership of a company held by common stock shareholders. This consists of the total value of all outstanding shares of common stock and additional paid-in capital (APIC) and retained earnings.
What Is Common Stock?
Stock shares represent an investment in a company that translates to partial ownership of the company. There are two kinds of stock that companies can issue: common stock and preferred stock. Each type of stock comes with certain rights, advantages and disadvantages.
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If a company issues only one kind of stock, it will be common stock. The writers at Sharestates explain some of the rights of common shareholders and the risks of owning common stock. Common stockholders have the right to vote in the company, able to elect or vote against directors. Common stockholders can also sell their stock at any time. Common stockholders are also more likely to share in a company's success.
Drawbacks of Common Stock
However, common shareholders are last in line to claim company assets in the case of a company's failure and may or may not be entitled to dividends. If dividends are paid, they go to preferred shareholders first, as explained by the Business Development Bank of Canada.
Likewise, if a company is dissolved, its assets go first towards repaying debtors and preferred stockholders (Sharestates notes that preferred stock behaves in some ways like both equity and debt). Only after those debts have been cleared would common shareholders receive any remaining payout. However, in most cases, preferred shareholders do not have voting rights.
Once you understand the characteristics of common stock, asking what a company's common equity is is a sensible thing to investigate about a company you're investing in or considering investing in. Deriving the common equity is also the first step in obtaining further useful metrics such as Return on Common Equity, or ROCE.
What Is Common Equity?
A company's common equity represents the total amount of all investments made by common equity investors, meaning common stock shareholders, including the value of all shares of common stock and its APIC and retained earnings.
Retained earnings, as explained by Sharestates, are profits set aside to be reinvested in the company. Additional Paid-In Capital (APIC) is the capital raised by the company from the initial sale of stock above its par value. Companies prefer to set very low par values for their stock so that, in the case of stock prices falling, the par value will not exceed the stock's market value. Otherwise, the company would owe its shareholders money.
To arrive at a company's common equity, multiply its outstanding shares by their par value and add that to its APIC and retained earnings. This can be found on the company's balance sheet, generally under the stockholders' equity section. For example, if a company has 10,000 outstanding shares with a par value of $0.50, an APIC of $5 million and retained earnings of $1 million, then its common equity is (10,000 x $0.50) + $5,000,000 + $1,000,000 = $6,500,000.
Return on Common Equity
A company's common equity is an important part of calculating its Return on Common Equity ratio, or ROCE. The Business Development Bank of Canada team explains that a company's ROCE is a measure of what kind of return common investors get relative to how much they originally invested in the company.
It is one of five profitability measures alongside gross profit margin, net profit margin ratio, return on total assets and return on total equity. Note that ROCE isolates the return on common equity only, separate from preferred stockholder equity.
Writers from The Corporate Finance Institute provide the following formula for a company's ROCE: Net Income for the given period / Average Common Equity for the given period (obtained by taking the common equity at the beginning of the period, adding it to the common equity at the end of the period, and dividing that sum by 2).
Consider also: What Is Included in a Common Stockholder's Equity?