Shareholders’ equity (capitaux propres) represents what actually belongs to a company’s shareholders: the difference between everything the business owns (its assets) and everything it owes (its liabilities). It is a central indicator of a company’s financial strength and is used to calculate several key ratios for investors, such as return on equity (ROE) or the price-to-book ratio. This guide explains what it is made of, how to read it on a balance sheet, the ratios built on it and the pitfalls to avoid, with concrete examples.
On a balance sheet, the company presents on one side its assets (fixed assets, inventories, receivables, cash) and on the other its sources of funding: liabilities and shareholders’ equity. The fundamental equation is:
Shareholders’ equity = Total assets – Total liabilities
Shareholders’ equity corresponds to the money brought in by shareholders plus the profits accumulated and not distributed over the years. It is also known as total equity or balance sheet equity — in French company accounts you will see it called fonds propres or situation nette.
| Element | What it contains |
|---|---|
| Share capital (capital social) | The par value of the shares issued |
| Share premium (primes d’émission) | The amount paid by shareholders above par value during capital increases |
| Reserves (réserves) | Profits from previous years kept within the company |
| Profit for the year (résultat de l’exercice) | The year’s profit or loss, before allocation |
| Other items | Foreign-currency translation adjustments, revaluations and treasury shares (deducted) |
| Minority interests (intérêts minoritaires) | In consolidated accounts, the portion of subsidiaries owned by other shareholders |
- It increases with retained profits and capital increases.
- It decreases with losses, dividends paid out and share buybacks (see our definition of treasury shares).
Negative shareholders’ equity means that liabilities exceed assets: it is a warning sign, even though some highly profitable companies that buy back their own shares on a massive scale can show this situation without being in difficulty.
Return on Equity (ROE)
ROE = Net income / Shareholders’ equity. It measures what the company earns for every euro contributed or left in by shareholders. A ROE sustainably above 15% is generally considered a sign of a profitable company, provided it is not achieved through excessive debt.
The Gearing Ratio (Debt-to-Equity)
Gearing = Net debt / Shareholders’ equity. It compares the company’s borrowings with its own resources. A ratio above 100% indicates a company financed more by debt than by its shareholders, which increases the risk in a downturn.
The Price-to-Book Ratio (P/B)
P/B = Market capitalization / Shareholders’ equity. A ratio below 1 means the stock market values the company below its book value, which may point to undervaluation or to doubts about the real worth of its assets — a way of comparing shareholders’ equity with market cap in a single figure. European banks traded below book value for years after the 2008 crisis.
A Worked Example
A company has €1,000 million of assets and €600 million of liabilities, of which €400 million is net financial debt. Its shareholders’ equity amounts to €400 million. It generates net income of €60 million and is worth €800 million on the stock market:
- ROE = 60 / 400 = 15%;
- gearing = 400 / 400 = 100%;
- P/B = 800 / 400 = 2.
The market is paying twice the book value, which reflects solid profitability, but the heavy debt load calls for vigilance.
Shareholders’ equity also determines a company’s ability to reward its shareholders. Under French company law, a company may only distribute its distributable profit (bénéfice distribuable): the profit for the year increased by previous profits set aside as reserves, and reduced by previous losses and mandatory reserves. A company whose shareholders’ equity has been badly dented by losses must rebuild it before paying a dividend. Conversely, a company that keeps piling up cash and substantial equity with no investment project may decide to hand part of that money back to shareholders, through special dividends or share buybacks. Tracking shareholders’ equity over several years therefore makes it possible to anticipate a company’s distribution policy.
Pitfalls to Avoid
- Book value is not market value: a plot of land bought fifty years ago may be worth far more than its balance-sheet amount; conversely, acquisition gaps (goodwill) can overstate the real value.
- Intangible assets are poorly captured: brands, patents developed in-house and know-how often fail to appear on the balance sheet, which explains the high P/B ratios of technology companies.
- A high ROE can come from debt: always read it alongside the company’s level of indebtedness.
For banks and insurers, equity sits at the heart of regulation: institutions must hold a minimum level of shareholders’ equity in proportion to their risks. To find out more, read our definition of prudential regulation.
To dig deeper into analysing company accounts, see our guide to fundamental analysis. To take short-term positions on shares around earnings releases, some investors use CFDs; our Vantage review looks at a broker that offers them. CFDs are leveraged products carrying a high risk of loss. This article is informative and does not constitute investment advice.
It appears on the liabilities side of the consolidated balance sheet, published in the universal registration document (document d’enregistrement universel) and in the annual and half-year results announcements. The statement of changes in equity breaks down every movement of the year: profit, dividends, share buybacks and capital increases.
In Summary
Shareholders’ equity measures the wealth of shareholders as recorded on the balance sheet. It underpins essential ratios such as ROE, gearing and the price-to-book ratio. But it should never be read in isolation: profitability, debt levels and the true quality of the assets, which accounting reflects only imperfectly, must complete the picture.
FAQ
By subtracting the company’s total liabilities from its total assets.
That liabilities exceed assets. It is often a sign of difficulty, except for certain highly profitable companies that have bought back large amounts of their own shares.
What Is ROE?
Return on equity: net income divided by shareholders’ equity. It measures the return generated on shareholders’ money.
This article is educational in nature and does not constitute investment advice.
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