What are Common Stocks?

5paisa Research Team

Last Updated: 05 Jul, 2024 06:09 PM IST

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Common stocks are a type of investment that allows individuals to own a small piece of a company. By purchasing common stocks, investors can potentially benefit from the long-term growth of the company and receive dividend income. Common stocks are a popular investment option for many people, but they come with risks as well as potential rewards. Whether you're new to investing or looking to expand your portfolio, this post will provide you with valuable insights into the world of common stocks.

What are Common Stocks?

Common stocks, also known as common shares or equities, are units of ownership in a publicly traded company.

When an individual buys common stocks, they become a part-owner of the company and have a claim on a portion of its assets and earnings. Common stocks are the most widely known and traded type of stock and typically offer the potential for long-term growth and dividend income. The price of common stocks fluctuates based on market demand and supply, and investors can buy and sell them on a stock exchange through a stockbroker or online trading platform. 

Companies issue common stocks to raise capital to fund their growth and expansion plans. As a shareholder, an individual has the right to vote in the company's annual meetings, participate in major decisions affecting the company's future, and receive a portion of the profits through dividends, if declared.
 

Why are Common Stocks Issued?

Companies issue common stocks to raise capital to fund their business operations, expansion plans, research and development, acquisitions, and other strategic initiatives. By issuing common stocks, companies can tap into a broad pool of investors and raise large sums of money without incurring debt obligations. Additionally, issuing common stocks can help companies to enhance their public profile, improve their credibility, and attract talented employees. Common stocks can also be used to make acquisitions, as companies can exchange their stocks for the target company's stocks, thereby acquiring its assets and operations.

Features 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.
 

Benefits of Common Stocks

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.
 

Who Should Invest in Common Stocks?

Investing in common stocks can be suitable for long-term, growth-oriented, risk-tolerant, diversified investors who have adequate savings and emergency funds. Common stocks offer the potential for long-term growth and capital appreciation, dividend income, and ownership in companies. However, investing in stocks carries risks such as market volatility, company-specific risks, no guaranteed returns, dividend risk, inflation risk, and limited control. Investors should conduct due diligence on companies before investing and carefully consider their individual financial situations, and goals.

Common Stocks and Balance Sheet

Common stocks are part of shareholders' equity and appear on a company's balance sheet. They represent ownership in the company and give shareholders voting rights on certain matters. The value of common stocks can change based on a company's performance and market conditions. Issuing additional common stock can increase equity, but it can also dilute the ownership interest of existing shareholders. Overall, common stocks play an important role in the balance sheet, representing ownership interest and influencing the value of shareholders' equity.

Common Stocks vs Preferred Stocks

Feature                 

Common Stocks

Preferred Stocks

Ownership             

Shareholders own a portion of the company, with voting rights.

Shareholders own a portion of the company but usually have no voting rights.

Dividend Payments.

Paid after preferred stock dividends have been paid

Paid before common stock dividends.

 

Dividend Amount.   

Dividends are not guaranteed and can vary based on company performance

Dividends are usually fixed, with a set amount paid on a regular basis.

Liquidation             

Has a lower priority in the event of liquidation.

Have a higher priority in the event of liquidation.

 

Risk             

Higher risk, but also higher potential return.

Lower risk, but also lower potential return.

 

Convertibility          

Generally not convertible into other securities.

It can sometimes be converted into common stock.

 

Voting Rights.

Shareholders have voting rights

Shareholders usually do not have voting rights.

 

 

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Frequently Asked Questions

To vote at company meetings, you must own common stock in the company. Receive a Notice of the Meeting and review the Proxy Statement, which includes information about the matters to be voted on. Submit your proxy vote online, by phone, or by mail, or attend the meeting in person with proof of ownership.

Common stock is referred to as equity because it represents ownership in a company. Purchasing common stock means owning a share of the company, which gives you voting rights and a share in the company's profits. As an owner, you have an equity interest in the company and a residual claim on its assets.