The world of investing can be a very confusing one, and one that moves very fast. So it's understandable if you want to get involved but aren't sure where to start.
If you're a beginner and curious about common stock, it's important to know common stock can come with more responsibilities than you may realize - and more risks than you might have realized too.
If you're looking to invest in your first company, you should know: what is common stock, what do you need to know about it and how does it compare to other types of stocks?
What Is Common Stock?
Common stock is what is most associated with an investor owning stock, the shares of a company that an investor has in their portfolio. It's a big-tent phrase that encompasses a lot of what is available on the market - whether a public company is big or small, or whether they're better for growth investing or value investing, they are offering common stock.
When a company decides to go public and make shares available to prospective investors, they announce an initial public offering (IPO). IPOs are a way for company to acquire additional capital, giving them the funding that they deem makes them able to give out stock publicly. Through the process leading up to an IPO, the company works with an underwriter (generally an investment bank), who determines the price of the stock.
This stock is merely the certification that you, the investor, have given money to the company and received a sliver of ownership in exchange. Once you've bought common stock in the company, it's yours to hold onto or, if you choose, sell. Ideally, you'll have found a good time to sell when the price of the stock is demonstrably higher than it was when you first bought it, but the risk inherent in stock means that isn't always going to be the case.
Even if you sell your common stock, you've been holding onto it and watching changes in the price. The biggest and most obvious reason investors get involved in common stock is that they believe if they get involved with a certain company at the right time, the stock price may go up significantly.
If everything goes right, you could be worth a lot more than you were when you first bought it, and be in a great position to sell and cash out. If things don't go right, and the price of your common stock starts falling, you will need to figure out whether to keep holding on in hopes of a rebound or cut your losses.
Another reason for buying common stock in a company is because more often than not, shareholders with common stock get to have a say and vote in certain decisions for the company as part of their ownership stake.
There are, occasionally, companies that offer common stock that gives you voting rights AND common stock that doesn't allow it. These will be represented as different "classes" of common stock, with different tickers. The most famous example of this is tech giant Alphabet, Inc.; class-A shareholders (GOOGL - Get Report) get a vote, while class-C ones (GOOG - Get Report) do not.
A company's shareholder equity is reflected on their balance sheet, along with its assets and liabilities. Under the shareholder's equity section will be a line for "common stock," which represents the par value of the stock. Usually, this ends up being around one cent per share. This section will also have a line for paid-in capital, also known as capital surplus, which is the amount the company received for issuing out its stock.
Advantages of Common Stock
Common stock can be risky, but there's no part of investing that isn't risky. If you do your research and act as carefully as you can, there can be many different advantages to holding common stock - some you may not have even thought about when you first decided to invest.
As mentioned earlier, most companies offering common stock allow you voting rights. Generally, shareholders get one vote per share.
The things you are voting on deal with corporate matters. Shareholders will vote on a company's board of directors, or on whether or not to adopt a corporate policy change.
This isn't always the reason that investors may buy common stock, but for some investors it's a crucial reason. Those who buy stock in a company they have a particular interest in may specifically want the opportunity to play a role in the company's operations instead of sitting back and watching the price fluctuate.
Potential for Profit
Of course, if you are just in the common stock game just to hold onto the shares and see what happens with the price, this also has the potential to become a major advantage. While common stock is far from the only security you can buy on the stock market, it tends to have more potential for bigger profits than preferred stock or bonds.
Of course, that volatility is as much risk as advantage, so you'll still need to approach this with caution. But taking the time to learn more about the market and investing, and which companies are worth investing in, makes you better prepared to make a better choice. And if you hit on the right stock at the right time, common stock is an easily liquidated asset for when you want to sell.
Do some more research on the companies you want to invest in; you may find that not only do you get voting rights, but dividends as well! Dividends are a share of the company's profit, and common stockholders are all given proportional shares of the dividend payout. If your shares are doing well and you're getting dividend payouts, you're getting quite a bit from your investment. Some investors choose to reinvest dividends back into the company, so they are using the dividends to buy more shares of the stock.
Dividend payments for common stockholders, however, aren't quite as common as voting rights. If you're getting a dividend payment, the company will announce its intention to do so in advance.
Risks of Common Stock
Play your cards right, and you can make a nice profit off of common stock. But we don't always play cards right even with our best efforts. There is a ton of risk in investing in common stock, in ways that can go beyond just taking a loss.
The fact of the matter is, as a common stockholder you're easily the lowest priority compared to the other shareholders. And if things goes south for the company, that could be very bad for you.
Let's say you chose the wrong company to invest in, and they end up filing for bankruptcy and liquidating their assets. You as a common stockholder are owed assets. But first the bondholders get their assets, as well as the preferred shareholders and anyone else the company was in debt to. You're way, way down the line.
If you have quite a bit of your money sunk into a failed investment via common stock, you could find yourself in real financial trouble while waiting for your liquidated assets.
Not All Advantages Are Guaranteed
Many of the advantages of common stock can be great, but don't go into buying stock assuming you'll get them. If you don't do proper research before investing, you could wind up with a lesser investment than you had anticipated. Not every company offers dividends with common stock, and while most do offer voting rights it's not unheard of for split stocks where some don't get them.
The volatility of common stock compared to other securities can work in your favor with the right investment, as common stock has a tendency to outperform the others. But the wrong investment, in the wrong market, means that volatility can come back to bite you. At the end of the day, the riskiest thing about common stock is the incredible amount of risk inherent in investing, period.
Common Stock vs. Preferred Stock
Perhaps you've heard of preferred stock in addition to common stock. From the name, it sounds like a more exclusive form of stock. But what actually is it?
Preferred stock is another form of stock ownership in a company, one that has some similarities to common stock and some to bonds as well. The differences between preferred stock and common stock include:
- Preferred stockholders do not have voting rights on company decisions.
- Preferred stockholders also get dividends, but unlike with common stock the dividend is a fixed amount. The dividends for preferred stockholders are also given priority.
- Preferred stockholders have a higher priority for receiving assets in the event of bankruptcy and liquidation. They are the second group paid after bondholders, with common stockholders after that.
- Preferred stock, as a common stock/bond hybrid of sorts, is less aggressive or prone to volatility than common stock.
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