Shareholders' Equity

• Shareholders' equity refers to the total amount that all shareholders would be entitled to after a business sold all its assets and paid off all its debts. The shareholders' equity gives you a good idea of how much the company is worth overall, which tells you whether the business is a good investment. If you know how many shares of stock in the company exist, you can divide the shareholders' equity by the number of shares of stock to figure out how much a share of stock would be worth.
  
  

Debt-to-Equity Ratio

• Balance sheets also list a business's debt-to-equity ratio: how much debt it has relative to the shareholders' equity. The debt-to-equity ratio tells you whether the business takes on an unreasonable amount of debt If the business has far more debt than it does equity, the business is probably not a good investment because it is taking in more debt than it is taking in investment income. For example, if a business has a 3:1 debt-to-equity ratio, that means that it is paying out $3 in debt for every dollar it takes in in investments.
  
  

Initial Investment

• If a business is new, its equity usually reflects its investors' initial investments, as these constitute most of the business's assets. As a business grows, its equity reflects revenue the business earns and puts back into the business as well as the initial investment. Thus, if a business is relatively new and is already earning significant revenue toward its equity, the business is probably a good investment, but if the business is not yet earning significant revenue it still may grow.
  
  

Considerations

• While the business's equity is a good indicator of its health, you should not depend on the equity alone when making investment decisions. Examine the business's assets carefully. If most of its assets are fixed, such as land or buildings, it can take a long time to liquidate those assets if the business needs to do so, and the assets may depreciate over time. You should also examine the business's income and expenses to determine whether the business makes wise financial decisions on a daily basis.