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By Doreen Martel

Why stock equity makes good collateral

Drip Investor defines equity as "The investment by shareholders in a company. It is equal to total assets less total liabilities." A further review finds that the definitions of equity investment are "Investment into a company via the purchase of the company's stock." This means that in spite of the fact that most people may consider "equity" only in their home, there may be companies that owe them money that they are not aware are considered equity investments.

Understanding shareholder investments

When a shareholder invests in a company through the purchase of non-bond related mutual funds, through dividend reinvestment plans or through the purchase of shares in a company through a stockbroker, they have an equity investment in the company. This means that if the company should go bankrupt, the company is obligated to pay the shareholders based on their equity investment. Though the various classifications of stock may limit the amount of funds that are available for collecting, equity investments represent a shareholders stake in the company.

Understanding stock equity

When a shareholder invests in a company via directly purchasing their stock through a DRIP program, purchasing stock through a broker dealer or by purchasing a stock based mutual fund, they have equity in the company. However, the types of shares may have an impact on how equity is divided among shareholders in the event that a company files for bankruptcy.

Understanding equity-based securities

Treasury stock is defined by Investopedia as stock that was once outstanding but has been subsequently repurchased by the company. This stock has no voting rights. It does not pay dividends, and the company is under no obligation to reissue them. Shareholders will never see treasury stock, though they may have shares that are recalled to be categorized as "treasury stock." It is not uncommon when a company is seeking new capital that they will do a sale of equity and later recall the stock.

Preferred stock is issued by a company with a promise of equity to the shareholder. Definitions of equity investment often begin with preferred stock as it carries certain promises to the equity holder. Shareholders of preferred stock must be paid their dividends before the equity holders of common stock and in the event that a company is liquidated, they must be paid first. Preferred stock has both debt and equity features.

Common stock represents a shareholder's equity in a company. Unlike preferred stock, however, equity stock contains no debt features. Common stock shareholders, while having an equity position in the company, are paid after preferred shareholders, bond holders and other debt holders of the company.

For those who are considering investments in mutual funds or stock shares, it is important to understand proper definitions. Equity investment occurs when you purchase stock in either common shares or preferred shares. While preferred shares also have a debt feature, they are still considered an equity investment in the company. Investors who invest in mutual funds that comprise stocks also hold equity positions. Bond positions are always considered a debt investment.

Article sources

Drip Investor:
SEC Guide to Mutual Funds
Investopedia: Common Stock; Preferred Stock; Treasury Stock

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