Common shares or common stock is a class of stock issued by corporations that represent ownership in the corporation for shareholders. The hope is that the company will grow and prosper, driving up the price of their shares. Being a common shareholder is a way for investors to benefit from the growth of a company.
What are common shares?
Common shares are what most people think of when they hear the term “stock.” Common stock is traded on a number of exchanges including the New York Stock Exchange, the American Stock Exchange, and the NASDAQ market. These stocks include shares of prominent companies such as Apple, Disney, Microsoft, Amazon, and many others. There are also many shares of companies that you many never have heard of traded every day as well.
Companies issue shares of common stock in an effort to raise capital to fund the company. Companies raise funds from a variety of other methods including issuing bonds which represent a long-term debt obligation of the company. They might also borrow from a bank or utilize credit from suppliers for some of the major purchases they make.
The money raised from the creation and issuance of shares of common stock of the company will be recorded on the company’s balance sheet as equity. The company might also retain ownership of some shares or buy back some shares if it makes good financial sense to do so.
Owners of common shares are allowed to vote for the company’s board of directors and other corporate issues that might arise over time.
How common stock works
Companies will issue shares of common stock when they first go public in what is called an initial public offering. You may hear about IPOs in the news from time-to-time. Rideshare company Uber is a recent example of company doing an IPO. This represented the first time that the investing public was able to buy and sell shares in the company.
Companies may issue additional shares after they initially go public, but this will depend on a number of factors, including the company’s need for additional capital. Companies may go into the market and buy back shares of their stock if they feel the shares are undervalued and represent a good long-term investment for the company.
Once shares of common stock are issued, they are traded on an exchange. The price of the shares are determined by supply and demand. If there is high demand to own the company’s shares, buyers will bid the price up. If demand for the stock is low, the price will likely decline as sellers will be forced to sell their shares at a lower price.
The number of shares available to buy or sell is finite and is determined by the number of shares that have been issued by the company over time. The total number of shares issued by the company is finite, new shares are only created if and when the company issues new shares of stock.
How to make money investing in common stock
There are two ways to make money investing in common stock.
The most common way investors make money from investing in stocks is through price appreciation of the shares they own. When a company’s revenues and profits are growing, investors often bid up the price of their stock. This might also occur for companies that are perceived to have future potential by investors even though they are not yet profitable.
Another way that investors can profit off of their stock investments is through dividends. Many, but not all, companies pay dividends to their shareholders. Dividends are quarterly distributions from the company’s earnings. Dividends are usually paid in cash but can also be paid as shares or stock or other property of the company.
There is no guarantee that the value of any stock in which you invest will appreciate in value, of course. Stocks are risky, and you can lose money.
How to invest in common stock
In order to buy and sell shares of stock you will need to open a brokerage account. Traditionally shares of stock were traded through stockbrokers who would charge a commission (transaction fee) to facilitate the trade.
While stockbrokers still exist, today it is relatively easy to buy and sell stocks online via most brokerage firms. Commissions at discount brokerage firms are generally much cheaper than having a broker facilitate the trade.
Another way to invest in stocks is through mutual funds and ETFs that invest in the shares of many company’s stocks. These are professionally managed funds that allow even small investors to invest in a diversified portfolio of stocks.
There are ETFs and mutual funds that invest in virtually all types of stock including U.S. stocks, foreign stocks, stocks of large companies, small companies, and mid-sized companies. There are funds that actively try to pick a portfolio of stocks that will outperform the market and others that passively seek to replicate the performance of a stock market index like the S&P 500.
In differentiating between large, small and mid-cap stock funds and ETFs, the average market cap (short for market capitalization) is what is used. Market cap refers to the overall value of all shares of the company’s stock in the marketplace. It’s calculated by multiplying the total number of shares of the company’s stock outstanding times the price per share.
At the time of this writing, the five largest stocks by market capitalization in the S&P 500 index were:
Microsoft
Apple
Amazon
Facebook
Berkshire Hathaway
Generally, small cap stocks will carry more risk than large cap stocks. This is because they may not be as widely traded as large cap stocks like the one’s listed above and there could be liquidity issues in some extreme cases for sellers. Also, these are typically smaller companies whose business may consist of one product or service, if there is an issue that is financial damaging to that business the company’s earnings will likely suffer.
Many experts recommend a mix of stocks by market cap, foreign, and U.S., and other categories. Using a robo advisor like Wealthsimple can help you with get started and determine the best asset allocation for your situation.
Common versus preferred shares
Common shares are the most commonly issued class of stock by companies. However, companies may issue multiple share classes of stock for various reasons.
Preferred shareholders have a preference compared to holders of common stock when it comes to the payment of dividends. In other words, if a dividend were to be declared and there was insufficient cash to pay the full amount to both common and preferred shareholders, then the preferred shareholders would have a preference and would be paid first.
According to Morningstar, the bulk of preferred shares are issued by utilities, financial institutions and telecom companies.
A major difference between preferred and common shares is that unlike common shares,preferred shares do not come with voting rights. This pertains to electing the company’s board of directors as well as voting on corporate policy issues that might arise from time-to-time.
This preference feature of preferred stock also extends to any claims on the company’s assets. In event of liquidation, preferred shareholders are paid before common shareholders. Though both types of shareholders are paid after the company’s creditors.
Some preferred shares may offer the option for shareholders to convert their shares to shares of the company’s common stock. This may or may not ultimately be beneficial for shareholders based on a number of factors such as the price of the common shares over time.
Both common and preferred stock come with the potential for price appreciation.
Preferred stock has many characteristics that make these shares seem more like bonds than common stock. In fact, they are often thought of as a hybrid between stocks and bonds.
Preferred shareholders usually receive a fixed dividend payment per share on a continuous basis. The dividend yield at any point in time is calculated by taking the current annual dividend per share and dividing this by the price per share.
Generally, preferred shares behave like bonds when it comes to their price movement. Bond prices in the secondary market move inversely with
. In other words, if interest rates increase, the price at which a bond can be bought or sold will decrease. The price of many preferred stocks react the same way to changes in interest rates.
While there are many similarities between preferred stocks and bonds (which are generally considered less-risky than other types of investments), preferred stock also has a number of risk factors.
Preferred shares usually have a call feature. This means that the shares can be called back or redeemed by the company. The shareholder will receive a predetermined redemption price if the shares are called. This will typically be a higher price than the “par value” (or face value) of shares but may be higher or lower than the current market value of the shares.
Beyond any price risk, the shareholder will be losing the dividend payments that might represent a significant income stream. Depending upon where interest rates are at the time, they may have trouble reinvesting the proceeds of the redemption in another security that offers the same level of current income.
For those who are interested in preferred stock, but are uncomfortable picking individual company’s preferred shares, there are mutual funds and ETFs that invest in preferred stock. These might be a good alternative for investors who want exposure to this category.
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