Common Stock: What It Is, Different Types, vs. Preferred Stock

What Is Common Stock?

Common stock is a security that represents ownership in a corporation. Holders of common stock elect the board of directors and vote on corporate policies. This form of equity ownership typically yields higher rates of return long term. However, in the event of liquidation, common shareholders have rights to a company's assets only after bondholders, preferred shareholders, and other debtholders are paid in full.

Common stock is reported in the stockholder's equity section of a company's balance sheet.

Key Takeaways

  • Common stock is a security that represents ownership in a corporation.
  • In a liquidation, common stockholders receive whatever assets remain after creditors, bondholders, and preferred stockholders are paid.
  • There are different varieties of stocks traded in the market. For example, value stocks are stocks that are lower in price in relation to their fundamentals. Growth stocks are companies that tend to increase in value due to growing earnings.
  • Investors should diversify their portfolio by putting money into different securities based on their appetite for risk.
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What Is The Difference Between Preferred Stock And Common Stock?

Understanding Common Stock

Common stock represents a residual claim to a company's ongoing and future profits. As such, shareholders are said to be part-owners in a company. This does not mean that shareholders can walk into a company's offices and claim ownership of a portion of the chairs or desks or computers. These things are owned by the corporation itself, which is a legal entity. Instead, the shareholders own this residual claim. Common stock is traded on exchanges and may be bought and sold by investors or traders. Shareholders of common stock may be entitled to receive dividends.

The first-ever common stock was established in 1602 by the Dutch East India Company and introduced on the Amsterdam Stock Exchange. Over the following 400+ years, stock markets have appeared around the world, with tens of thousands of companies listed on global stock exchanges such as the London Stock Exchange and the Tokyo Stock Exchange, among others.

Larger U.S.-based stocks are traded on a public exchange, such as the New York Stock Exchange (NYSE) or NASDAQ. As of Q1 2022, the NYSE had 7,417 listings with a market capitalization totaling around $53 trillion, making it the biggest stock exchange in the world by market cap. There are also several international exchanges for foreign stocks, Companies that are smaller in size and unable to meet an exchange’s listing requirements are considered unlisted. These unlisted stocks are said to be traded over-the-counter (OTC).

Special Considerations

Corporate Bankruptcy

With common stock, if a company goes bankrupt, the common stockholders do not receive their money until the creditors, bondholders, and preferred shareholders have received their respective share. This makes common stock riskier than debt or preferred shares. The upside to common shares is they usually outperform bonds and preferred shares in the long run. Many companies issue all three types of securities. For example, Wells Fargo & Company has several bonds available on the secondary market. It also has preferred stock, such as its Series L (NYSE: WFC-L), and common stock (NYSE: WFC).

IPOs

For a company to issue stock, it must begin by having an initial public offering (IPO). An IPO is a great way for a company, seeking additional capital, to expand. To begin the IPO process, a company must work with an underwriting investment banking firm, which helps determine both the type and pricing of the stock. After the IPO phase is completed, the general public is allowed to purchase the new stock on the secondary market.

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Common Stock and Investors

Stocks should be considered an important part of any investor’s portfolio. They bear a greater amount of risk when compared to CDs, preferred stock, and bonds. However, with the greater risk comes the greater potential for reward. Over the long term, stocks tend to outperform other investments but are more exposed to volatility over the short term.

There are also several types of stocks. Growth stocks are companies that tend to increase in value due to growing earnings. Value stocks are companies lower in price in relation to their fundamentals. Value stocks offer a dividend, unlike growth stocks. Stocks are categorized by market capitalization - either large, mid, or small. Large-cap stocks are much more heavily traded and are generally an indication of a more stable company. Small-cap stocks are usually newer companies looking to grow; so, they can be much more volatile compared to large caps.

How Does Common Stock Differ From Preferred Stock?

Common stock is the most widely available type of shares issued by a company and what you will likely encounter when trading stocks on an exchange. These shares typically come with voting rights, but are the last in line in the preference ordering of being repaid if a company goes bankrupt. Preferred shares come ahead of common stock in that ordering. Preferred shares also often lack voting rights, but do come with regular and higher dividend payments. In this respect, preferred shares are sometimes considered to be a hybrid between bonds and common stock.

How Can I Use Common Stock to Vote at Company Meetings?

Most ordinary common shares come with 1 vote per share, granting shareholders the right to vote on corporate actions, often conducted a company's meeting of shareholders. If you cannot attend, you can choose to cast your vote by proxy instead, whereby a third party will vote on your behalf (along with others who cannot attend). Votes may be held on issues such as whether to merge with or acquire a company, to elect members of the board of directors, or to approve stock splits or dividends.

Why Is Common Stock Referred to as an Equity?

Common stock represents a residual ownership stake in a company. A company maintains a balance sheet composed of assets and liabilities. Assets are the things that the company owns or is entitled to, such as its property, equipment, cash reserves, and accounts receivable. On the other side of the balance sheet are liabilities, which are what the company owes. These include payables, debts, and other obligations. If a company is healthy, the total assets will be larger than the total liabilities. What is left over is the residual amount left to the owners, known as shareholders' equity. This is represented by a company's shares.

Article Sources
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  1. NYSE. "Listings Directory."

  2. SIBLIS Research. "NSYE Total Market Cap."

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