What is Debt Vs. Equity?

One of the questions I am asked on a regular basis when educating people about stock trading is, “Why would a company issue stocks?”

The answer is in the difference between debt and equity.

I’m sure the reader is familiar with the idea of debt, but as it relates to a publicly traded company, debt means private ownership and responsibility of paying that down and off. Most of the time these private companies, when they need capital (whether $10k for a new pizza oven at Mama’s Pizza kitchen, or $10mill for a technology based global company to put towards R&D) they will do what we do; borrow from a lender like a bank or other financial institution. This puts paying back the loan, with interest, squarely on the shoulders of the company’s owners.

Equity, by contrast, is where a company determines its assets and monetary value (which includes an earnings forecast) and offers a portion of that value to investors called shareholders. The equity of the company, and what the individual shares are worth, are what makes keeping an eye on your investments critically important. This type of system also means that the majority shareholders (typically billionaires and investment firms) have a say in how said company is run.

The advantages of equity to a company of any size is that no interest is paid because the money used for new projects, expansion, and other related things are drawn from the value of the company rather than a lender. This process is much like the way that your income tax is used on a governmental level (though with this model there is less red tape and political corruption; to be sure the one influences the other in major ways both directions).

The stocks based on the equity of the company rise and fall as profitability does, and so these stocks are traded continually at current value. The idea is that when the time comes to trade or sell these shares they will be worth more than when they were purchased, equaling a profit made for the investor.

Contibutors: Germantown TN Roofers

Again, this is bare bones education. There are deeper levels of understanding that you will gain as you become more trade savvy.

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