What Is Common Stock?
A security that represents an investor’s ownership in a corporation is the common stock of the company. Those who hold common stocks elect the board of directors of the company possesses voting rights to vote on corporate policies in the company. Common shareholding, as a form of equity ownership, can yield higher returns in the long term. In the event of the company’s liquidation, the common shareholders possess the right to claim the company’s assets after the preferred shareholders, bondholders, and other debtholders have been paid in full.
One can issue common stocks from the company’s initial public offering (IPO). The company’s balance sheet has a stockholder equity section where common stocks are reported. To express the number of common stocks a company is offering, one can subtract the total treasury stocks from the total number of shares issued.
Understanding Common Stock Meaning and Purpose:
Now that we know what is the ‘common stocks’ definition, the question arises: what is the purpose of issuing them? The primary goal for issuing common stocks is raising capital. The capital that is raised by the company can be used for the following purposes:
- Acquisition of a promising company
- Creating a future cash reserve
- Paying off outstanding debts
One of the consequences of issuing common stocks is that the market dilutes the holding power of the pre-existing shareholders. Depending upon the goal of the company, they may either want to avoid dilution or to aim for it. Hence, these motivations may lead to a company issuing more common stock.
Common Stock Advantages
The benefits of issuing common stocks can be summarised as follows:
- Voting rights
One voting right is vested to an investor per share of each common stock held. These voting rights allow investors to partake in the creation of corporate policies and other business decisions. Investors, in some cases, can elect the board of directors by exercising their voting rights. The more common stocks an investor has the more power they have to sway the policies in a company.
- Potential profits
When compared to deposit certificates and bonds, common stocks tend to perform better. There is no upper limit on how much an investor can earn from their common stock holdings. These stocks are also a less expensive and more feasible alternative to debt investment.
- Limited legal liabilities
Beyond the financial investment events that occur within the company, the obligations of common shareholders cease to exist. They need not be concerned with legal liabilities. When the company is generating steadily growing returns across time, common shareholders are passive recipients of a fixed income of sorts. As passive shareholders, they are not responsible in case the company liquidates or gets into legal issues.
Common stocks can be easily invested or surrendered by investors as they are liquid. These stocks help investors not only buy more shares but also walk away with their funds if the company is not performing up to their mark. Liquidity offers the investors flexibility to do with their investments what they see fit without much hassle.
Common Stocks Limitations
There is no guarantee of payouts even though common shareholding can be considered as a fixed income option. However, the difference here is that the income may not be guaranteed at the time in which one expects it based on the availability of funds in the company and how they are allocating those funds. When the company is allocating dividend payouts to investors common stockholders are not the ones to receive priority payouts. They receive their dividends after preferred shareholders and bondholders have received their dividends in full. Hence there is a degree of uncertainty and a lack of control when it comes to how profitable common shares are.
- Market Risks
Another risk associated with common shares is market risk. Market risk is the issue of the company underperforming over time. A decline in performance can lead to the profits being eaten into and shareholders not getting the dividends they are vying for. This is a crucial parameter to consider because common shareholders are not the first to receive benefit payouts even when the company is performing well.
Offering common stock is a way of sharing passive ownership in a company. Investors with common stock possess voting rights without the strains of company legalities. However, the profitability of common stocks is somewhat limited by how they are prioritized in payouts and the company’s freedom to defer dividends until funds are available.