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Does Stockholders' Equity Increase When Stock Is Issued?

Original post by Nola Moore of Demand Media

A stock issue is like cutting a pie into eight pieces instead of six -- there's less good stuff per person.

Shares of stock represent ownership in a company, so it's logical to believe that more shares are better. However, if the underlying value of the company -- the stockholders' equity -- has not changed, more shares just mean more pieces cut from the same pie. Often, issuing new shares of stock has little bearing on the total value of shareholders' equity, only in the way that equity is divided.

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Stockholder's Equity

Stockholders' equity is the net worth of a company -- all its assets minus all its liabilities. It is this net worth that investors trade when they buy and sell stock. At any given time, the amount of net worth an investor owns is equal to the equity divided by by the total number of outstanding shares, times the number of shares the investor owns. So if Sir Allen's Breastplate Company has 400 shares of stock outstanding and a stockholders' equity of $400,000, the net worth owned is $1,000 and each share represents 1 percent of the company. If you hold 10 shares, you own 10 percent of the total stockholders' equity, or $40,000.

Types of Stock Issue

There are three ways a company can issue additional stock, and only one of them affects stockholders' equity, albeit somewhat indirectly. A direct issue of shares means that the new shares are sold on the stock market for the going rate, and the company takes in revenue from the sale. This revenue becomes an asset and increases stockholder equity. Note that the company must turn revenue from a stock sale into long-term assets and profits for there to be any long term effect to the stockholders' equity. A stock split or stock dividend awards current stockholders with additional shares in proportion to what they already own: one share for three, for example. The company does not receive payment for these shares, so there is no increase in assets and no change to stockholders' equity.

Stock Issues in Reports

Shares of stock on their own aren't assets or liabilities for the issuing company, so they cannot change stockholders' equity. Shares of stock do appear on the statement of stockholders' equity, however, and this may be confusing. A stock issue is added as a credit valued at "par," usually $1 or less. This same value is reduced in the retained earnings column -- a net effect of zero. In some cases, the company will record expenses related to the stock issue as a credit to "paid in capital," but again, this same value is debited from retained earnings, so the net effect on stockholders' equity is still zero.

Share Dilution

Any time additional stock is issued, the company risks share dilution. Share dilution is a reduction in the value of each individual stock because each share represents a smaller share of a stockholders' equity that has not grown significantly. In some cases, this may be beneficial. Shares that are too expensive may not be easy to purchase. On the other hand, shares issued can indicate a company that is cash-poor and in financial trouble.


                   

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About the Author

Nola Moore has been writing articles since 1999. Based in Santa Monica, Calif., Moore writes and blogs about taxes, trading and trusts for a variety of publications including BankShout, CreditShout and various other websites. She holds a Bachelor of Science in retail merchandising and spent nearly a decade in trust and investment services before leaving Minnesota for the beach.

Photo Credits

  • ITStock Free/Polka Dot/Getty Images


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