What Is Common Stock?

What Is Common Stock?

Let me tell you directly: common stock isn't just some document; it's your entry into owning part of a company. When you own common stock, you get to vote on things like the board of directors and company policies. You also stand to receive dividends if the company decides to pay them out. Over time, this can lead to solid returns, but there's a downside you need to know. If the company liquidates, you're last in line for any assets after bondholders, preferred shareholders, and creditors take their shares. You'll find the value of common stock listed in the stockholder's equity section of the company's balance sheet.

Key Takeaways

Understand this: common stock is a security that gives you ownership in a corporation. In liquidation, you as a common stockholder get what's left after everyone else is paid. You typically have voting rights in company elections. Preferred stock, on the other hand, offers more reliable dividends but no voting rights usually. As an investor, diversify your portfolio with different securities based on how much risk you can handle.

Understanding Common Stock

Common stock is essentially your claim on a portion of a company's assets and earnings, making you a part-owner. But don't think that means you own the office furniture or equipment; those belong to the corporation as a separate entity. What you have is a residual claim, meaning you get what's left after all debts and obligations are settled. You can buy and sell these stocks on the market, and you're entitled to dividends from earnings, decided by the board.

Historically, the first common stock came from the Dutch East India Company in 1602, traded in Amsterdam. Since then, stock markets have popped up worldwide, like in London and Tokyo, listing thousands of companies. In the U.S., big stocks trade on the NYSE or Nasdaq, with Nasdaq having about 3,377 listings as of mid-2024, though NYSE leads in market cap. Smaller companies trade over the counter if they don't meet exchange requirements.

What Is Preferred Stock?

Preferred stock is a different class altogether, giving you rights that common stock doesn't. Both types mean ownership, but preferred holders have a stronger claim on assets and dividends, which is why it's called 'preferred'.

Common Stock vs. Preferred Stock

Both common and preferred stock let you own a piece of the business, but you need to grasp the differences. Common stock gives you voting rights to influence corporate policies and board elections, while preferred usually doesn't, though it can vary. Dividends for common aren't guaranteed and depend on the board's choice, but preferred dividends are fixed and must be paid before common ones. In liquidation, preferred holders get paid before you as a common stockholder. Common can't convert to other securities, but preferred might convert to common. Common is more volatile, tied to company performance, while preferred is steadier with fixed dividends. Common holders benefit from company growth, but preferred typically stick to those fixed payouts.

Voting Rights

As a shareholder, you vote on key management decisions, like electing the board. Common stock usually gives you this right, but preferred often doesn't.

Dividends

Both types can get dividends, but preferred ones are preset based on par value and rate. Companies decide on common dividends flexibly. If funds are short, preferred get paid first, and cumulative preferred accumulate arrears that must be cleared before common dividends.

Trading and Price Changes

You can trade both on the open market, but common stocks are traded more often. Preferred have less volatility due to fixed dividends, making them appealing for steady income, especially to institutions. They're less liquid, so not ideal for quick trades if you're a retail investor.

Corporate Bankruptcy

In bankruptcy, common stockholders wait until creditors, bondholders, and preferred are paid. This makes common riskier, but they often outperform long-term. Companies like Wells Fargo issue all types: bonds, preferred like Series L, and common stock.

Initial Public Offerings

Companies go public via IPO to raise capital, working with banks to set stock type and price. After IPO, stocks trade publicly on secondary markets.

Advantages and Disadvantages

Consider this for common stock: it's traded more, offers higher potential returns, and gives voting rights, but dividends aren't guaranteed, you have lower priority in payouts or bankruptcy, and prices fluctuate more. For preferred: higher dividend priority, less volatility, fixed dividends that don't drop, but often no voting, lower returns, and less frequent trading.

How to Invest in Common Stock

Stocks are key to your portfolio, riskier than CDs or bonds but with higher long-term rewards despite short-term swings. Choose growth stocks for rising earnings or value stocks for dividends and undervaluation. Stocks vary by size: large-cap for stability, small-cap for growth but more volatility.

How to Invest in Preferred Stock

Buy preferred like common, but research the issuer carefully since a weak company risks both. Check dividend yield against price for returns. Note if callable, which could end your dividends early, or convertible, which might benefit if common prices rise.

Explain Like I'm Five

Common stock is basic company ownership: vote for leaders and get dividend shares. Some companies have multiple types with varying rights. Preferred means no vote usually, but better dividends and first dibs in liquidation.

How Do I Use Common Stock to Vote at Company Meetings?

Most common shares give one vote each for actions like mergers or board elections. Vote in person or by proxy if you can't attend.

Why Is Common Stock Called an Equity?

It represents residual ownership after liabilities, shown as shareholders' equity on the balance sheet where assets exceed liabilities.

Why Do Companies Issue Preferred Stock?

To raise money without giving voting rights, for expansion or debt. It's less dilutive, more stable, and can be cheaper than bonds since dividends aren't mandatory or tax-deductible.

Is Preferred or Common Stock a Better Investment?

Common offers higher returns with volatility for long-term investors; preferred is steadier for those avoiding swings.

Are There Other Different Types of Stock?

Mainly common and preferred, but some companies have classes like Alphabet's GOOG and GOOGL.

The Bottom Line

Common stock gives you business stake, voting, and asset claims, but preferred get priority on dividends and liquidation. Know this when investing.