6 mins read . 21 Nov 2022
When we talk about equity market, we often use the terms like stocks, shares and equity interchangeably. At a colloquial level that is correct. You can use equity stock, equity shares and equity interchangeably. However, you must also understand that there is a very subtle difference between equity and shares or stocks.
To buttress the terms stocks and shares can be used interchangeably. They mean one and the same thing, but equity is a different concept altogether. Normally, stocks and shares manage from equity, which is the fount of risk capital of a company. Here we look at the types of equity shares and also at the equity and share difference from a conceptual perspective.
Have you wondered how equity is different from stocks? Let us start with the balance sheet of a company. When you say shareholder equity what does that mean. It means the share capital, the free reserves created out of profits and the share premium account. In short, shareholder equity is everything where each shareholder has proportionate claim to. The shareholder has claim to the capital provided and to the profits ploughed back as well as to any premium collected on issue of shares. These things put together represent the equity. Equity is there for every company limited by shares, irrespective of whether it is a private limited company, public limited company, listed company or unlisted company.
When we talk of stocks, however, we only talk about listed stocks that are listed and traded on a recognized stock exchange. Therefore, the essential difference between stocks and equity occurs due to an event called listing of shares. Remember, every stock has a face value and it has a market value. The difference between market value and the face value is the valuation assigned to the stock by the market. This market value is a function of the free reserves which is part of equity. Shareholder equity can also be seen alternatively as the net assets of the company (i.e. total assets minus outside liabilities). That is equity.
The concept of stock only arises when a part of the equity is given to the public shareholders. Equity technical means ownership of the company or the capital and value that the promoters bring to the business. The equity becomes a stock only when these shares get listed and are routinely traded on the stock exchanges. Once the stock is listed, it can be bought and sold like any market linked asset at the prevailing market prices. Equity per se cannot be trade, but stocks can be traded. The promoter never gives the entire equity, which is the net value of the business. He only gives a part of the equity as stock. But the market price of the stock normally represents proportionate value of the company. In brief, equity is the amount of capital invested by a promoter of the company and in return holds the ownership of the company while stocks are equity shares issued to the general public to raise capital in return of ownership share in the company.
We know that equity is the share capital plus premium plus free reserves in the balance sheet of the company, which is also the net assets of the company. That raises a question of what is the value of such equity and is it the same as the value of the stock. The best measure for the value of a stock is market cap. For instance, when a company has 1 crore shares outstanding and its market price is Rs180, then the market value is Rs180 crore. That is the total value of the stock. While market value is a reasonable approximation of value, there is another valuation which is used in M&A, which is business value.
The market value of equity is the business value. That would include the value of the net assets of the company, plus the present value of future cash flows and the value of any brands, copyrights, patents and other intangibles. Normally, that is what the market price tries to capture. That is why you find that the market price is normally a good approximation of business value and so the market value of equity tends to converge towards the market value of the stock. What you see in the balance sheet of the company is the book value of equity. What you see in the stock markets is the market value of the stock. That should clarify the difference.