What are Common Stocks?

Common Stocks Definition

Common stocks also called common shares or equities represent ownership in a publicly traded company. When you buy common stocks you become a part owner of that company and have a claim on some of its assets and profits.

Common stocks are the most well known and widely traded type of stock. They offer the potential for long term growth and can also provide dividend income. The price of common stocks changes based on how many people want to buy or sell them and you can trade them on a stock exchange through a broker or an online trading platform.

Companies issue common stocks to raise money for their growth and expansion. As a shareholder you have the right to vote at the company's annual meetings, help make important decisions about its future and receive a share of the profits through dividends if they are declared.

How Common Stocks work?

Common stocks represent ownership in a company and allow investors to share in its profits. When individuals buy common stocks they become shareholders and gain rights such as voting in company decisions during annual meetings. The value of common stocks fluctuates based on market demand, company performance, and economic conditions.

Companies issue common stocks to raise capital for growth, research and expansion. Investors can earn returns through capital appreciation and dividends. Stocks can be traded on stock exchanges allowing investors to buy or sell them easily. The risk is that if the company performs poorly the stock value may decline and dividends may not be paid making it essential for investors to research before investing.
 

Types of Common Stocks

Common stock types can be divided based on their characteristics and investment potential.

1. Growth Stocks: These stocks come from companies that are growing quickly and often reinvest their profits back into the business. Examples include Bank of Baroda and Bajaj Auto. Investors buy growth stocks hoping their value will increase over time.

2. Value Stocks: These stocks are considered undervalued meaning their prices are lower than what the company is worth based on fundamentals. Investors look for these stocks because they believe their price will rise as the market realizes their true value.

3. Large Cap Stocks: These are shares of well established companies with a market capitalization of over ₹20,000 crore. Examples include Tata Consultancy Services and Cipla. Investors prefer these stocks for their stability and the dividends they often provide.

4. Mid Cap Stocks: These stocks belong to companies with a market cap between ₹5,000 crore and ₹20,000 crore. Investors seek a mix of growth potential and stability with these stocks.

5. Small Cap Stocks: Small cap stocks are from companies with a market cap of less than ₹5,000 crore which often have high growth potential. Investors target these stocks for growth, accepting higher risks for the chance of better returns.

Each type of common stock offers different opportunities, so investors need to choose based on their financial goals and how much risk they are willing to take.
 

Why are Common Stocks Issued?

Common stocks are issued primarily to raise money for various financial needs. Companies often choose to issue common stocks instead of taking on debt through bonds or selling preference stocks. The money raised can be used for several purposes such as paying off debt, expanding the business, acquiring other companies or building up cash reserves.

However, issuing new common stocks can dilute the ownership of existing shareholders, meaning their share of the company becomes smaller. Because of this potential dilution the decision to issue new common stocks is often a debated topic among a company's management.
 

Importance of Common Stocks for Investment

Common stocks play a crucial role in investment portfolios for several reasons. Firstly, they offer the potential for long term capital appreciation allowing investors to benefit from the company’s growth and increasing share prices. Additionally common stocks often provide dividend income, offering a source of cash flow while holding the investment. 

Investing in common stocks also grants shareholders voting rights enabling them to influence important company decisions. Moreover common stocks are highly liquid meaning they can be easily bought or sold on stock exchanges providing flexibility to investors. 

Finally, including common stocks in a diversified investment portfolio can help manage risk as they tend to outperform other asset classes over time. Overall common stocks are vital for investors seeking growth, income and participation in the companies they invest in.
 

Featues of Common Stocks

1. Ownership: When an investor purchases common stocks, they become a part-owner of the company and have a claim on a portion of its assets and earnings.

2. Dividend Income: Companies may distribute a portion of their profits to their shareholders in the form of dividends. Dividends are typically paid out quarterly, although the company's board of directors may choose to increase or decrease the amount paid based on their financial performance.

3. Voting Rights: As a shareholder, an individual has the right to vote on important company decisions, such as electing the board of directors or approving significant business transactions.

4. Volatility: Common stocks are subject to market volatility, meaning their prices can fluctuate significantly based on market demand and supply.

5. Capital Appreciation: Common stocks offer the potential for long-term growth and capital appreciation, meaning that an investor may be able to sell their shares for more than they purchased them for.

6. Limited Liability: In most cases, an individual's liability is limited to the amount they invested in the company's common stocks, meaning they are not personally liable for the company's debts or obligations.

7. Liquidity: Common stocks can be bought and sold on a stock exchange, making them a relatively liquid investment. However, it's important to note that fees and commissions may be associated with buying and selling stocks.
 

Difference between Common Stocks and Preferred Stocks

Common stocks and preferred stocks are two types of equity that represent ownership in a company but they come with distinct features. When you purchase common stocks you gain ownership and have the right to vote on important company decisions such as electing the board of directors. Common stockholders may receive dividends but these payments can fluctuate based on the company’s performance and are not guaranteed. The potential for capital growth is one of the attractive aspects of common stocks. If the company performs well the value of your shares may increase. However, in the event of bankruptcy common stockholders are last in line to receive any payments meaning they only get paid after all debts and preferred stockholders are settled.

In contrast, preferred stocks also represent ownership but come with different terms. Preferred stockholders usually do not have voting rights which means they have less influence over company decisions. However, they benefit from fixed dividends that are paid out before any dividends are distributed to common stockholders making their income more stable and predictable. While preferred stocks may not experience the same level of price growth as common stocks they tend to be less volatile and provide more consistent returns. Additionally if a company goes bankrupt preferred stockholders have a higher claim on assets than common stockholders, meaning they are more likely to recover some value. Ultimately, choosing between common and preferred stocks depends on your investment goals and how much risk you are willing to take.
 

Benefits of Common Stocks Investment

1. Long Term Growth: Common stocks have the potential to offer long-term growth and capital appreciation. Historically, stocks have outperformed other asset classes over the long run, although past performance is not a guarantee of future returns.

2. Dividend Income: Some companies pay dividends to their shareholders, which can provide a source of regular income. While dividends are not guaranteed and can be cut or suspended by the company, many investors find them to be a valuable aspect of investing in common stocks.

3. Ownership: When an individual buys common stocks, they become a part-owner of the company and have a say in its management and direction.

4. Diversification: Investing in common stocks can be a way to diversify a portfolio and reduce overall risk. By spreading their investments across different companies and sectors, investors can reduce the impact of any one company's poor performance.

5. Inflation Protection: Stocks can provide a hedge against inflation, as the earnings and dividends of companies may increase with inflation over the long term.

6. Liquidity: Common stocks are relatively liquid and can be bought and sold on a stock exchange, making it easy for investors to enter and exit positions.

Limitations of Common Stocks

Here are some limitations or risks associated with investing in common stocks:

●    Market Volatility
●    Company-Specific Risks
●    No Guaranteed Returns
●    Dividend Risk
●    Inflation Risk
●    Limited Control

1.  Market Volatility: The price of common stocks can fluctuate significantly based on market conditions, economic events, and company-specific factors. This volatility can lead to significant losses for investors, especially those who are not prepared for the risks involved.

2. Company-Specific Risks: Investing in common stocks of a particular company carries the risk of company-specific risks, such as poor management, product failure, or legal issues, that can affect the stock price.

3. No Guaranteed Returns: Investing in common stocks offers no guaranteed returns. Investors may lose some or all of their investments, especially if they invest in companies that underperform or go bankrupt.

4. Dividend Risk: While dividends can provide a source of regular income for investors, companies are not required to pay dividends, and the amount paid can be reduced or suspended at any time.

5. Inflation Risk: While stocks can provide a hedge against inflation, high inflation can reduce the purchasing power of dividends and earnings over time.

6. Limited Control: While investors have the right to vote on major company decisions, they may not have significant control over day-to-day operations, management decisions, or corporate strategy.

Overall, investing in common stocks carries risks and limitations that investors should be aware of before investing. Investors should carefully consider their individual financial situation and goals and conduct due diligence on companies before investing in their stocks.
 

Common Stocks vs Preferred Stocks

Common Stocks and Balance Sheet

By now you have learned common stocks meaning, common stock preferred stock etc.   Information about a company’s common stocks is usually found in the stockholder’s equity section of its Balance Sheet. This section provides insights into the book value or net worth of the company’s shares. Essentially, stockholder’s equity represents the book value of the company’s stock and reflects its intrinsic value, helping investors estimate what they might receive if the company were to liquidate.

However, the trading price of stocks doesn’t always match this book value. Fast growing companies often trade for much more than their book value reflecting their potential for future growth. On the other hand struggling companies may trade at a price lower than their book value indicating challenges in their performance or market perception.

Conclusion

Common stocks are an important part of investing, as they can provide high returns and give you ownership in successful companies. However, they also come with risks and uncertainties. Investors need to understand the different types of common stocks, their features, benefits and limitations so they can make informed decisions about their investment portfolios. Comparing common stocks to preferred stocks can help investors align their investments with their financial goals and risk levels.

If you're interested in investing in common stocks, the first step is to find a trustworthy stockbroker to help you with the process. For a smooth and secure investment experience, you might consider opening a Demat and trading account with 5paisa.