At its core, investing in common stock centers around the potential for investors to realize capital appreciation. It’s a straightforward concept: you purchase a stock at a low price and sell it at a higher price in the future, potentially increasing your initial investment.

There are thousands of companies whose stock trades publicly and have used the sale of equity to raise business capital. All publicly traded companies must issue common stock before issuing any other type of equity security. There are two types of equity securities: common stock and preferred stock. At the same time, all publicly traded companies must issue common stock; not all choose to issue preferred stock. However, before we dive in, let’s unpack the term equity.

Equity = Stock

The term equity, or “stock,” signifies more than just an investment. It creates a unique ownership relationship with the issuing company. Once you invest in a corporation’s stock, you become a part-owner with a say in the company’s decisions. The corporation sells portions to investors through shares to raise working capital. Equity is perpetual, meaning there is no maturity date for the shares, and you may own the shares until you decide to sell them. Most corporations use the sale of equity as their primary source of business ‘working’ capital.

Valuation of Common Stock

A common stock’s market value is determined by supply and demand, which may or may not have any real relationship to the shares’ worth. The market value of common stock is also affected by the company’s current and future expectations.

Some investors have heard the term “book value” of a corporation, which is the theoretical liquidation value of the company. The book value is found by taking all of the company’s tangible assets and subtracting all of its liabilities. This will give you the total book value. To determine the book value per share, divide the total book value by the total number of outstanding common shares.

Here’s an example:

XYZ’s assets are worth $10 million, but its total liabilities (debt) are $8 million. The company has 3,000,000 outstanding shares.

Assets – Liabilities = Book Value

$10 million – $8 million – $2 million

Book Value (divided by) Outstanding Shares = Book Value per Share

$2,000,000 / $3,000,000 = $0.66 (book value per share)

Dividends = Income

Investing in common stock is not just about buying and selling. Many companies distribute their profits to shareholders as dividends, which are considered a reward for being a shareholder. These dividends are typically paid out quarterly, and the amount you receive is a percentage of what you paid for the stock, known as the dividend yield.

An easy example would be to understand this simple equation:

XYZ stock pays its shareholders a $0.50 quarterly dividend and trades at $20 per share. What is its current yield, also known as dividend yield?

Current yield= annual income/current market price

0.50 x 4 = $2.00 $2/$20 = 10%

In this example, the investor would receive 10% of the stock’s dividend purchase price each year. Remember that all investors are subject to tax on dividends received.

What Are The Risks?

The primary risk in owning common stock is that its value may decrease. It’s crucial to understand that there are no guarantees when investing in any stock, and even if you own stock in a great company, there’s always a chance you may lose part or all of your investment. Being aware of these risks is an essential part of informed investing.

Another risk factor in owning common stock is that shareholders are not entitled to receive dividends based on their ownership of a share in the company. It is entirely up to the company to pay a dividend in the first place. The corporation is not obligated to pay a dividend to common shareholders, regardless of whether dividends have been distributed in the past.

Residual Claim To Assets

In the event of a company’s bankruptcy or liquidation, common stockholders have the right to receive their proportional interest in residual assets. For this reason, common stock is the most junior security.

For example, if the company is liquidated, common stockholders are the last to get paid. After all creditors and other investors are paid, the common stockholder will have little to no residual claim to their investment.

What Are The Rewards?

As an owner of common stock, investors are owners of the corporation. As such, investors are entitled to certain rights or benefits.

Suppose a corporation chooses to sell additional shares to raise new capital. In that case, they must first offer the “new shares” to existing shareholders before offering them to the general public, also referred to as a “preemptive” right.

A rights offering ensures a common stock shareholder’s preemptive right. The existing shareholders have the right to purchase the new shares at a discount to the current market value for up to 45 days, also referred to as the subscription price. A common stockholder has a few choices regarding what they might do with the “preemptive” right.

1. Investors can exercise their preemptive right by purchasing additional shares at a discount to the current market value during those 45 days.
2. Suppose the investor does not want to purchase any additional shares of the corporation, even at a discount to market value. In that case, they can sell the “preemptive” right to another investor who wants to purchase the shares.
3. The investor also has the option to take no action and allow the “preemptive” right to expire after the 45-day window.

Voting

As a common stockholder, you have the right to vote on the corporation’s significant issues. You are a part owner of the company and have a right to say how it is run. The biggest emphasis is placed on the election of the board of directors.

Common stockholders may vote on the following:

• Issue of Bonds or Additional Common Shares
• Stock Splits
• Mergers and Aquisitions
• Changes in Corporate Policy

The voting process uses two methods: statutory and cumulative. A stockholder may cast one vote for each share of stock owned, and the statutory or cumulative method will determine how those votes are cast.

Freely Transferable

High liquidity is one of the most lucrative common stockholder benefits. As an investor, no penalties are incurred compared to other investment vehicles, whether you are selling stock shares at a gain, at a loss, or breaking even. Additionally, the transfer of a securities ownership is executed efficiently in the secondary market on an exchange in the over-the-counter OTC market or by a broker-dealer.

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