Can Equity Value Be Negative? A Guide to Avoiding Financial Issues

Equity value can indeed be negative, and it's essential to understand why this happens. According to our research, a negative equity value occurs when the outstanding balance on a loan exceeds the market value of the asset.

This can happen when the market value of the asset decreases, such as in a real estate market downturn. For example, if you bought a house for $200,000 with a $150,000 mortgage, but the market value of the house drops to $180,000, you would have negative equity.

The consequences of negative equity can be severe, including the risk of foreclosure or being forced to sell the asset at a loss.

Equity Value can't be negative because it's calculated by multiplying Share Price by Shares Outstanding, and both of those values must be positive.

In theory, Equity Value can't be less than 0 because it's a product of two positive numbers. However, Implied Equity Value can be negative, indicating the market expects a company to keep burning through cash.

A company with a negative Enterprise Value will often turn around as the market's view shifts, or it will go bankrupt if the market's view is correct. This is a rare scenario that tends not to last for very long.

Implied Share Price can be $0.00 if you get negatives in calculations, and you'll rely more on methodologies like Liquidation Valuation for distressed companies.

A company's negative equity value can arise from a share repurchase, which involves spending money to buy outstanding shares, thereby subtracting from its assets and shareholder equity.

This can be a deliberate financial move, but it's not the only reason for negative equity. Many new companies start with a negative equity value because they've had to borrow money before generating profits.

Borrowing money to fund operations is a common practice, and it's not uncommon for companies to take on debt to get started.

Borrowing money can be a necessary step for many new companies, especially if they need to start earning profits before they can pay off their debt.

Borrowing money creates a liability on the balance sheet, which reflects the debt incurred by the company.

This debt is reflected as a negative asset, reducing the company's overall value.

A company can try to avoid negative equity by issuing new shares to raise funds, but this isn't necessarily a better option than borrowing money.

Issuing new shares dilutes the outstanding shares, causing current owners to own a smaller stake in the business, which can lead to a drop in share values.

Selling new shares can also lead to a decrease in share prices, making it a less attractive option for some companies.

Many new companies start with negative equity because they've had to borrow money before they can start earning profits.

By paying down the debt over time, a company can reduce its negative equity and increase its overall value.

Domino's Pizza has had negative equity since their 2004 IPO but has outperformed the S&P 500 by a cumulative 1,442%. McDonald's, H&R Block, Yum Brands, HP, Motorola, Denny’s, AutoZone, and Wayfair are also on the list of those with negative book value.

Most companies with negative equity are often written off as distressed, but they actually survive for years and have outperformed the market 57% of the time. There are currently 118 companies in the U.S. market with negative equity.

Lehman Brothers, General Motors, and Hertz Global Holdings had negative shareholders' equity before filing for bankruptcy in 2008, 2009, and 2020, respectively. General Motors and Hertz made comebacks, but Lehman Brothers imploded.

Issuing new shares to raise funds rather than borrowing money could be a strategy for avoiding negative shareholders' equity, but it also dilutes the outstanding shares, causing share values to drop.

Having negative equity on your home can be a big source of financial distress that can make it difficult to sell your home or obtain future financing.

You may struggle to sell your home because the sale price won't cover the outstanding mortgage balance, leaving you with a significant debt to pay off.

This can limit your financial options and make it harder to achieve your long-term financial goals.

Negative equity can also make it challenging to obtain future financing, such as a home equity loan or a mortgage refinance.

This is because lenders view homes with negative equity as higher-risk investments, which can make it harder to secure a loan.

Selling your home in a short sale or foreclosure can also have long-term consequences on your credit score.

Negative shareholders' equity can be a warning sign for established companies, but it's not always a deal-breaker. Large dividend payments can exhaust retained earnings or exceed shareholders' equity, leading to a negative balance.

Companies may issue large dividends for various reasons, including a short-term stock boost, investor expectations, competitive pressure, overconfidence, or to signal financial health. These reasons can have implications for the firm's financial health and stability.

If a company cannot manage its finances, it spells trouble.

Large dividend payments can have significant implications for a company's financial health. Companies may issue excessively large dividends to temporarily boost their stock price and attract new investors.

One reason companies do this is to meet investor expectations, as a history of solid dividends can set high expectations and investors may perceive reducing or skipping dividend payments negatively. This can create pressure on the company to maintain a certain level of dividend payments, even if it's not financially prudent to do so.

A company may also issue large dividends to stay competitive with peer companies, even if it's not financially viable. This can be a sign of overconfidence, where executives are overly optimistic about future earnings and cash flow.

Here are some reasons why companies might issue large dividend payments:

Negative equity is a serious concern for investors, but it's not the same as mortgage equity withdrawal.

Equity can be reduced when new liabilities are added to a property, but it doesn't necessarily mean the owner has lost equity.

In the context of investing, it's essential to understand the difference between equity and liabilities.

When evaluating whether to invest, consider the company's path forward, especially if it has negative equity. A close examination can help you determine if there's cause for optimism.

Young companies with negative equity can still succeed and grow, but established companies with negative shareholders' equity are a warning sign of financial distress.

You need to consider whether the company has a realistic chance of returning to profitability. This is crucial in deciding whether to invest.

In the case of young companies, borrowing money to invest in the business is a normal part of growth.

A share repurchase can cause negative equity because it involves spending money to buy outstanding shares, which is subtracted from the company's assets.

This can lead to a decline in shareholder equity, making it a common reason for negative shareholders' equity.

If a company conducts a share repurchase, it can spell trouble for its financial health.

The cash spent on the repurchase is a direct hit to the company's assets, leaving it with less value to distribute to shareholders.

Calculating shareholders' equity is a crucial step in understanding a company's financial health. It's a simple formula, but one that can reveal a lot about a company's stability.

Total assets minus total liabilities equals shareholders' equity. This calculation can be found on a company's balance sheet.

To calculate shareholders' equity, you'll need to know the company's total assets and total liabilities. Total assets include current assets like cash and accounts receivable, as well as noncurrent assets like property and equipment.

Here's a breakdown of the key components:

If total liabilities exceed total assets, the company will have negative shareholders' equity. This is a red flag for investors and should be investigated further.