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In the world of investments its important to know what you are getting into before you make a commitment from purchasing on your own or by an investment professional. Goal of this article is to teach you what is common stock, how is it used, what are some advantages and disadvantages plus risks involved.
What is Common Stock?
Common stock is a type of equity that allows investors to have a form of ownership from the issuing corporation or entity. The buyers of common stock are known as shareholders. It allows the investors to participate in the company’s prosperity. Investors can benefit from:
- an increase in price of the shares (capital appreciation)
- receiving earnings from distributed profits (dividends)
Why would a company issue common stock?
A company or entity issues common stock to raise capital. When they raise capital it allows the issuer to receive the funds since the shares where sold in the primary market.
Advantages of Common Stock
- Common stock holders have the right to vote for corporate directors
- Common stock is freely transferable to anyone who wants to buy it or receive as a gift (no permission of the corporation needed)
- Right to limited access of the corporations books (minutes of meetings of BOD, list of stockholders)
- Right to receive an audited set of financial statements of the company’s performance each year (annual report)
- Common Stockholders have the preemptive right to maintain their proportionate share of ownership in the corporation.
- Ex. If corporation wants to issue more shares, existing shareholders have the right to purchase those shares in an amount that would maintain their proportionate ownership in the corporation unchanged.
- Can receive growth (capital gains) when the market price increases in value. This is also known as capital appreciation.
- For long term investment horizon, can provide hedge against inflation
- Can receive income from dividends when declared by the Board of Directors (BOD)
- Common stock holders have limited liability
- Ex. If corporation becomes bankrupt, share holders cannot be forced to sell any personal assets to help pay the debts of the business
Why would you include common stock in your portfolio?
- Potential capital appreciation
- Income from dividends
- Hedge against inflation
What are the risks of Common Stock?
- Market Risk – Stock can decline in value and fluctuates daily
- price of a stock when investor wishes to sell may be higher or lower than when the shares were initially purchased.
- Business difficulties (leading to possible reduction or elimination of dividend) and potentially bankruptcy (leads to loss of principal or initial investment amount)
- Low priority at dissolution – if company enters bankruptcy, the holders of its bonds and preferred stock have priority over common stockholders