"Equity" in the stock market is defined as the amount of money left after all company liabilities have been subtracted from the total value of the company's assets. Equity helps measure a company's ability to pay back its investors. Negative equity is when a company's liabilities surpass the value of its assets. Even if the business liquidates all assets, it will not have enough cash to pay back all of its investors.
The top 3 reasons for negative equity include:
Decrease in the value of intangible assets
Intangible assets comprise copyrights, patents, and other forms of intellectual property. The reduction in the value of these intangible assets is a major factor contributing to a company's negative equity, especially if the assets have become outdated or have been disproved by other intellectual property.
Large Dividend Payment
When investors happen to resell their shares of stock to the company, the company pays them a dividend in the form of interest on their investment. When the dividend payments exceed the company's assets value, liabilities rise. Therefore, it is crucial for any company trading on the Indian Stock Exchange to maintain a dividend payout ratio that is consistent with the company's expected profits.
Lack of financial security because of mounting losses
Accumulated loss refers to a company's financial woes that have lasted through multiple fiscal quarters. It is not bad for a company to have accumulated losses, as quarterly profits and existing assets can offset them. However, negative equity results from a loss that significantly surpasses what can be covered by the company's assets.
Also Read: What is Put-Call Ratio?
Negative equity can impact day and swing traders who trade for shorter time frames. Therefore, to avoid financial loss, it is always recommended that investors carefully review the company's financial statements over several quarters before trading in their securities. A company's liabilities may not necessarily result from poor management if its equity is negative. Often, a business may take on debt or use most of its resources to invest in infrastructure upgrades that eventually pay off in the form of increased profits. Want to know more about it? Visit Nifty Trading Academy.