This is the ownership interest in the company and is composed of a common stock account and a retained earnings account. A common stock account will appear on the balance sheet when common stock with a stated par value (such as one dollar), meaningless from an investor's viewpoint, is sold. The account will reflect the par value of the shares sold. The paid-in-capital account records the amount initially paid by the shareholders above the par value of the common stock. Retained earnings are the accumulation of earnings, after all expenses and dividend payments. In effect, retained earnings represent the reinvestment of earnings into the firm.
Stockholder's equity is often referred to as the net worth of the firm. This represents the residual value after liabilities are subtracted from assets. Book value is another label attached to stockholder's equity. The usefulness of book value is limited because the balance sheet represents an accounting value that may be dramatically different from the market value. The market value of some of the unfinished goods in inventory may be below the accounting book value, while the market value of some of the property owned by the firm may be well above the stated book value. Service firms may have a substantial level of hidden intangible assets that will never be valued on the balance sheet. It is often said that the assets of a service company walk out the door every evening. While some investors select stocks for their hidden asset values, the majority of investors are concerned with the future earnings and cash flow generation potential of the assets held by the firm.
