Common stock is more than just a document or a digital entry; it’s a gateway to owning a part of a company. As a holder of common stock, you hold the power to influence corporate decisions by voting for the board of directors and corporate policies. While this type of equity offers potential long-term returns, it comes with its risks. In scenarios of liquidation, common stockholders are compensated only after bondholders, preferred shareholders, and other creditors have been settled.
The value of issued common stock is detailed in the stockholder’s equity section of a company’s balance sheet.
Key Highlights
- Ownership Representation: Common stock signifies ownership in a corporation.
- Liquidation Hierarchy: In case of liquidation, common stockholders get paid after all other creditors.
- Variety of Stocks: Stocks can be growth-oriented or value-based, each carrying its own set of features.
- Diversification: Spreading investments across different securities mitigates risk based on an individual’s risk tolerance.
Understanding Common Stock
Common stock is essentially an ownership certificate in a corporation, entitling you to a portion of the company’s assets and earnings. As a shareholder, you’re considered a ‘part-owner,’ though not in a literal sense regarding the company’s assets like office equipment; those belong to the corporation as an entity.
Residual Claims
Shareholders hold residual claims on profits and assets, meaning they are entitled to what’s leftover after settling all obligations.
Market Trading
Common stock can be bought and sold on exchanges, offering investors dividends decided by the company’s board of directors based on the entity’s performance and future goals.
Historical Context
The Dutch East India Company issued the first common stock in 1602. Today, stock markets worldwide list thousands of companies, with the NYSE being the largest by market cap.
Dissecting Preferred Stock
Preferred stock differs from common stock by offering higher claims on assets and dividends. Holders do not generally have voting rights but enjoy elevated status and often fixed dividends.
Comparative Analysis: Common vs. Preferred Stock
| Common Stock | Preferred Stock | |
|---|---|---|
| Voting Rights | Typically, holders have voting rights | Holders generally do not have voting rights |
| Dividends | Not guaranteed; paid at the board’s discretion | Typically fixed; must be paid before common stock dividends |
| Liquidation Priority | Last in line after bondholders and preferred stockholders | Higher claim priority over assets |
| Convertibility | They cannot be converted into other securities | May be convertible to common shares depending on terms |
| Volatility | Typically higher due to market conditions | Lower with a fixed income stream |
| Market Participation | Directly benefit from company’s increased value | Limited to fixed dividends; less prone to market fluctuations |
Understanding Your Rights and Benefits
Voting Rights
Common stockholders generally have voting rights to influence major corporate decisions via shareholder meetings or proxy voting. Issues voted on can range from board elections to mergers.
Dividends
Common stock dividends are at the discretion of the board. In contrast, preferred stock dividends are predetermined and prioritized.
Investment in Market Segments
Stocks can be part of varied segments like growth stocks focusing on earnings growth, value stocks cheaper concerning their fundamentals, or classifications by market capital such as large-cap or small-cap stocks.
What Happens in Case of Bankruptcy?
In bankruptcy scenarios, common stockholders receive their share after all other obligations, making it riskier but potentially more rewarding in the long run.
IPOs
Companies issue stocks through Initial Public Offerings (IPOs) to raise capital. Post-IPO, stocks become available to public investors in secondary markets.
Key Considerations: Advantages and Disadvantages
Common Stock Pros and Cons
Pros:
- Higher potential returns
- Trading volume is high
- Voting rights
Cons:
- Dividends not guaranteed
- Lower priority in dividends and assets distribution
- More volatile
Preferred Stock Pros and Cons
Pros:
- Priority in dividends
- Less volatility
- Guaranteed dividends
Cons:
- No voting rights
- Lower potential returns
- Less trading volume
Investing in Common Stock
Stocks’ long-term potential for rewards often surpasses other asset types, although they come with higher risks and short-term volatility. Investors can diversify among growth and value stocks and across market cap segments for balanced portfolios.
Investing in Preferred Stock
While similar to common stock trading, investing in preferred stock demands additional due diligence. Consider yield, dividends, and the potential for future capital appreciation if selling a barcode.
Practical Uses and Concepts
Voting With Common Stock
Ordinary shares often grant one vote per share, allowing shareholders to influence critical corporate policies and board elections.
Equity Explanation
Common stock symbolizes a residual ownership in the company’s equity value, i.e., assets minus liabilities.
Issuing Preferred Stock
Preferred stock helps in raising funds without dilution of voting rights, offering fixed dividends that stabilize the company’s finance.
Preferred vs. Common Stock
Each stock type offers distinct advantages, balancing potential returns against volatility. Investors with different risk profiles and objectives should choose accordingly.
Other Stock Types
Besides common and preferred stocks, companies might issue different classes. For instance, Alphabet has GOOG and GOOGL, each with distinct characteristics.
Concluding Thoughts
Common stock provides a stake in the company’s assets and future gains while incorporating voting rights. Preferred stock offers less risk with fixed return but no voting rights. Balancing between these types will depend on one’s risk appetite and investment horizon.
Related Terms: preferred stock, initial public offering, voting rights, stock market.
References
- New York Stock Exchange. “Listings Directory”.
- Investor.gov. “Stocks”.
