Common Stocks: A Deeper Dive (Voting Rights, Risks, Dividends)
Companies sell stocks to raise money, which they then use for initiatives like general corporate purposes, growth or new products. The biggest reason to invest in common stock is to earn a return on your investment when its stock price appreciates or when the company pays dividends. A liquid asset, stocks can be easily converted into cash.
As with any stock, when you own a common stock you become a shareholder, owning a piece of the company. This gives you a claim on the company's earnings, and many times the opportunity to vote on the future of the company; its board of directors, approving major corporate decisions like mergers and stock splits. Some companies have multiple classes of common stock, with different classes having more voting power than others (voting and non-voting).
Common stockholders often are entitled to dividends which would be distributed usually quarterly, though some pay monthly or semiannually. Stockholders can usually choose whether to receive their dividends as cash or to use them to buy additional shares of stock.
Common stocks are generally available on public stock markets and easy to purchase. You don't need to be an accredited investor or high-net-worth individual to invest.
The process a private company uses to become a publicly traded company, and therefore allow its shares to be owned by everyday investors, is known as its initial public offering, or IPO. Companies seeking to go public create these stocks by partnering with an investment bank, where the decision is made regarding the price of the stock and number of shares that will be made available.
Considered to be a high-risk asset class, common stocks are more volatile than bonds. They’re affected by both real and perceived risks (company-specific and industry-wide), and can cause you to lose some or all of your investment. Regulatory changes can restrict their growth potential or require companies to alter the way they do business. Additionally, the business valuation can be negatively affected by changes to the business model, the company's products can become obsolete, and competitors can put pressure on sales and profits.
If a company files for bankruptcy, common shareholders are last in line to be paid. They'll receive any remaining funds behind secured creditors such as banks, unsecured creditors such as bondholders, and preferred stockholders.
Stocks and bonds have an inverse relationship in terms of price, when stock prices rise, bonds prices fall. Your stock/bond allocation comes down to your risk tolerance.
A general rule of thumb is that your stock/bond portfolio allocation be equal to 100 minus your age. If you're 40, your portfolio should contain 60% stocks, 40% bonds.
To profit from your investment, you’ll need to sell the company’s shares at a higher price than you paid for them, generating a capital gain which can then be used as income or reinvested. Capital gains will be taxed as long-term or short-term gains by the IRS.
When looking at a company's balance sheet, common stocks are recorded in the "stockholders' equity" section. Here investors can determine the book value (stockholders' equity) of their shares, which equals the company's assets minus its liabilities.
The book value of the stock doesn't necessarily equal its trade value. Rapidly growing companies may trade for several times their book value, while riskier or struggling companies may trade at a discount.