Today I would like to dive into the question of what you are actually buying when you buy shares in a Publicly Traded company.
If you are anything like me you’ve been thinking: “What’s the point of buying shares in the first place?”
So why on earth would you want to buy an Equity share in a publicly traded company?
Is it solely because the company pays a dividend or is there any other reason why you would want to invest your hard earned cash into something so intangible as a share?
In order to answer the question we first need to understand the capital structure of a company.
As always we come back to the Fundamental Accounting Equation which looks like this:
Figure 1. The Fundamental Accounting Equation where Assets equal Liabilities plus Equity.
What this means is that when you have a publicly traded company you want your assets to be worth more than your debt so that the Equity portion is positive.
When the company is selling stock it is the Equity portion of the company divided by the number of shares outstanding that it is selling.
As always we can use Microsoft Excel to illustrate what we mean.
Let’s say that our company has a $1,000,000 in assets and $750,000 in liabilities. How much equity does the company have?
Figure 2. Screenshot of Microsoft Excel showing how to calculate the Equity portion by subtracting Liabilities (cell B2) from Assets (cell B1).
Then we can calculate how much Equity (or Book value) the company has per share by simply dividing Equity (cell B3) with number of shares (cell B4):
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