Common stock – definition and meaning
Common stock, a term more commonly used in the United States – while in the UK and much of the rest of the world people say ordinary share or voting share – is a form of corporate equity ownership, a kind of security.
Someone who owns common stock is called a common stockholder or common shareholder. They may also be referred to as simply shareholders.
Common stockholders are only paid dividends after all the preferred stock dividends are paid out in full. Preferred stock has a higher claim on the earnings and assets of a company than common stock.
If a company goes bankrupt, creditors (including employees), bondholders and preferred stockholders are paid any remaining funds before common stock investors. It is not unusual for investors with common shares to receive nothing after a business has gone into liquidation.
However, on average, common shares perform better than bonds or preferred shares over the medium and long term. Because of their superior returns, investors buy many more common shares than preferred shares.
Common stock – shareholders’ rights
If you own common stock you usually have the right to vote on who is on the board of directors. If the stock is of a ‘non-voting’ class, then you can’t vote. Preferred stockholders do not have voting rights.
People with voting common stocks have a say in the company’s objectives and policy and its stock split (when a company increases the number of shares outstanding).
In some cases, common stockholders may be able to retain their proportional ownership of the company if it issues more shares.
Unlike preferred stock, common stock has no fixed dividend payout – returns depend on the company’s earnings, how much it decides to reinvest, and the efficiency of the market to value and sell stock.
Many novice investors believe they should start off with preferred stock, rather than common stock. Experts say this might not be the best decision. Which type of stock to buy depends on the investors’ financial goals, whether they are interested in having voting rights in the company, and their tolerance for risk.
Earning money from shares
There are two ways people can earn money when they invest in stocks: dividends and price appreciation.
If the company you have shares in does well and earns well, its stock will become sought after – more investors will want to own some of the company that you have a stake in.
As demand for those shares rises, so does its price. This increase is known as price appreciation. If you sell those shares when their price has appreciated you will make money.
“The type of stock [common stock] that is present at every corporation. (Some corporations have preferred stock in addition to their common stock.) Shares of common stock provide evidence of ownership in a corporation. Holders of common stock elect the corporation’s directors and share in the distribution of profits of the company via dividends.”
“If the corporation were to liquidate, the secured lenders would be paid first, followed by unsecured lenders, preferred stockholders (if any), and lastly the common stockholders.”
Video – Types of stocks
This video talks about the difference between Common Stock and Preferred Stock, and the differences people should consider when deciding which stock to add to their portfolio.