Equity represents an ownership stake in a business. When an investor holds equity in a corporation, they own a fraction of that company's assets, earnings, and residual value. Equity is created when a company issues stock — either common stock (voting, residual claim) or preferred stock (fixed dividend, priority over common). Equity is on the right side of the balance sheet under shareholders' equity, representing the residual interest after all liabilities are deducted from assets.
From an investment perspective, equity investments offer the potential for capital appreciation (stock price increases) and income (dividends). Unlike debt holders, equity holders have no contractual right to a specific payment — their returns depend on the company's performance. This makes equity more volatile but potentially more rewarding than debt over long horizons.
Book value of equity (shareholders' equity) = Total Assets − Total Liabilities. Market capitalization = Share Price × Shares Outstanding. The price-to-book ratio compares market cap to book value, a measure of how much premium investors pay above accounting value.
The equity risk premium — the excess return investors expect from equities over the risk-free rate — is a fundamental concept in portfolio theory. Over long periods, equities have historically delivered higher returns than bonds, reflecting this premium for accepting higher volatility and uncertainty.
> Exam tip: On the Series 65/66 and CFP, understand equity's position in the capital structure (residual claimant after debt) and the difference between book value and market value of equity. Know how to calculate market capitalization. Equity return = dividend yield + capital gains yield — this decomposition is frequently tested.