Complete Guide To Corporate Finance

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Stock Valuation - Common Stock Features

Stock is sometimes referred to as shares, securities or equity. Simply put, common stock is ownership in part of a company. For every stock you own in a company, you own a small piece of the office furniture, company cars and even that lunch the boss paid for with the company credit card. More importantly, you are entitled to a portion of the company's profits and any voting rights attached to the stock. With some companies, the profits are typically paid out in dividends. The more shares you own, the larger the portion of the company (and profits) you own. (For related reading, see 10 Dividend Aristocrats.)

Common stock is just that: common. The majority of stocks trading today take this form. Common stock represents ownership in a company and a portion of profits (dividends). Investors also have voting rights (one vote per share) to elect the board members who oversee the major decisions made by management. In the long term, common stock, by means of capital growth, yields higher rewards than other forms of investment securities. This higher return comes at a cost, as common stock entails the most risk. Should a company go bankrupt and liquidate, the common shareholders will not receive money until the creditors, bondholders and preferred shareholders are paid. (To learn more about stocks, see our Stock Basics Tutorial.)

Objectives and Risks
Over the long term, no investment provides better returns at a reasonable risk than common stock. History dictates that common stocks average 11-12% per year and outperform just about every other type of security including bonds and preferred shares. Stocks provide potential for capital appreciation and income and offer protection against moderate inflation.

The risks associated with stocks can vary widely, and they usually depend on the company. Purchasing stock in a well-established and profitable company means there is much less risk you'll lose your investment, whereas purchasing a penny stock increases your risks substantially. If you use margin, you can also dramatically increase your leverage in a stock, but this is only recommended for experienced investors. (For more on stock investing, read Buffett: Penny Stocks, Day Trading Are My Real Key To Wealth.)

How to Buy or Sell It

The most common method for buying stocks is to use a brokerage, either full service or discount. There is no minimum investment for most stocks (other than the price per share), but many brokerages require clients to have at least $500 to open an account. Dividend reinvestment plans (DRIPs) and direct investment plans (DIPs) are two ways individual companies allow shareholders to purchase stock directly from them for a minimal cost. DRIPs are also a great way to invest money at regular intervals.




Strengths
  • Common stock is very easy to buy and sell.
  • Thanks in large part to the growth of the Internet, it is very easy to find reliable information on public companies, making analysis possible.
  • There are over 11,000 public companies in North America to choose from.




Weaknesses
Your original investment is not guaranteed. There is always the risk that the stock you invest in will decline in value, and you may lose your entire principal.
Your stock is only as good as the company in which you invest - a poor company means poor stock performance.


Three Main Uses
1. Capital Appreciation
2. Income
3. Liquidity
Preferred Stock Features
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