The common stock is a type of security, a form of corporate equity ownership. There are basic features of common stock that make the stock very popular among other stock types. Outside the United States, the term ordinary shares and voting shares are also used for this stock. While, in the UK and other commonwealth realms, they are known as ordinary shares or equity shares.
The common stock gives stockholders the right to share in the profits of the company and the right to vote on matters of corporate policy. Hence, common stockholders have the right to vote on the members of the board of directors. However, the common stockholders do not own any particular assets of the company.
A company may issue both ordinary and preference shares, where the owners of preferred shares have priority to receive dividends. In a case of liquidation, the common stockholders receive any remaining funds after creditors (including employees), bondholders, and preference shareholders have been paid. In a situation where the liquidation occurs through bankruptcy, the common stockholders usually receive nothing.
Therefore, because the common stock is more exposed to the risks of the business compared to bonds or preferred stock, the stock offers a higher potential for capital appreciation. Common stocks, despite their short-term volatility, tend to outperform more secure investments over the long term.
This article will discuss the basic features of common stock.
What are the features of common stock?
There are several features of common stock that make it unique. Ownership, voting rights for stockholders, long-term source of finance, dividends, capital gains, bankruptcy and liquidation implications, par value, no maturity, limited liability, residual claim, value not being concrete, tax exemptions, profit and risk relation, uncertain return, volatility, and fungibility are all features of common stock. These characteristics will be discussed below:
Basic features of common stock
- Voting rights for stockholders
- Long-term source of finance
- Benefits of dividends and gains
- Bankruptcy and liquidation implications
- Par value
- No maturity
- Limited liability
- Residual claim
- Value is not concrete
- Tax exemptions (Indirect)
- Profit and risks relation in common stocks
- Uncertain return
One of the basic features of common stock is that the stock provides ownership to the holders of common stock. This stock represents partial ownership of a company, meaning that the common stockholders are one of the owners of the company.
For instance, if a firm has 1000 shares traded in the market and a shareholder holds 100 shares of the firm, then the shareholder is the owner of one-tenth of the firm. This implies that should the firm get dissolved and its assets are liquidated, common stockholders would have the right to their portion of the proceeds if there is any remaining after creditors, bondholders, and preferred shareholders have been paid.
Voting rights for stockholders
The voting privilege for common stockholders is one of the features of common stock. Common stockholders are partial owners of the company and therefore have the right to weigh in on certain company issues. These shareholders express their opinion in the major decision-making for the company by voting e.g. mergers and acquisitions etc.
They may not get a say in the daily operating decisions for the company but they can vote in the election of the board of members and can partake at annual general meetings. This voting right is one of the major features of common stock. However, a company can decide to issue common stock with no voting rights or fewer voting rights compared to other stock classes.
Long-term source of finance
A good feature of the common stock is that it is a long-term source of financing. Common stocks are the most popular method to raise permanent capital.
Benefits of dividends
Because the holders of common stocks are partial owners of the company, they tend to benefit when the company is profitable. The benefit of dividends is one of the features of common stock as the holders of common stock have the right to receive dividends. The dividend is one of the most important and interesting parts of common stock. Hence, the image, capability, or attraction of investors vastly depends on the dividend declaration capability of the board. If the board of directors elects to declare payment of dividend, then common stockholders, have the right or capability of receiving dividend payments periodically.
Right to capital gains
Even if a company doesn’t pay dividends to common stockholders, it can still benefit when the company does well. The price of a stock may increase when the company does well. Therefore, common stockholders can make a capital gain from selling their stock more than how they purchased them.
When stockholders buy common stocks, the price may go up or down. So, common stockholders have the right to sell their shares to others and lock their profits. The appreciation in the capital is what is called capital gain.
For instance, assuming a common stockholder purchases stock when it costs $15 per share and it appreciates in value to $20 per share, the stockholder earned a $5 return on the investment. It is considered to be a capital gain when a stockholder sells the common stock for more than what he paid for it which is taxed at a rate that is more favorable compared to other income types.
Bankruptcy and liquidation implications
One of the features of common stock is that common stockholders are unlikely to receive any compensation compared to other stakeholders in the case of bankruptcy. If there are any remaining assets after liquidation, the company first uses them to settle debt holders such as bondholders and lenders. Then, pay back preferred stockholders for their investment. Should anything be left, the common stockholders are then entitled to a proportional share of the assets which doesn’t exceed their investment in the company.
This means that if a company becomes bankrupt, there is a big chance that common stockholders would lose everything compared to preferred stockholders. Different from common stocks, preferred stocks typically don’t have voting rights, they receive set dividends and trade at a different price than common stocks.
The par value of common stock is set by the issuer. Generally, one of the characteristics of the common stock is that the par value of the stock is divisible by 10 such as $10, $20, $50, $100, etc.
One of the important features of common stock is that it doesn’t have a maturity period. The stock remains a permanent capital as long as the company exists.
Offering limited liability is one of the features of common stock. The common stock is issued by corporations that give limited liability to their owners. This means that holders of common stock can’t lose more than their investment in the company. Therefore, in a case of bankruptcy, the stockholders may lose their investment but their liability is limited to their par value per investment.
For instance, the common stockholders may not be able to recoup their initial investment in the company if the company liquidates and can’t repay a debt. However, lenders can’t come after the personal assets of the common stockholders to fulfill this debt.
Therefore, there is limited liability in common stocks when it comes to liability of ownership. The portion purchased by the holder from the stock market is actually his/her total liability. This simply means that if a common stockholder holds 10 shares of a company that has 100 shares trading in the market, then the maximum amount that the stockholder can lose if the company goes bankrupt is the value of 10 shares.
The fact that common stockholders have residual claims on the income and other properties in an event of business failure, bankruptcy, or liquidation is a feature of common stock. If a business goes bankrupt and has paid the payable to the preferred stockholders of the company, then the common stockholder gets some portion of the remaining asset.
Value is not concrete
The value of common stocks is not concrete in the sense that the value fluctuates from time to time. One of the major features of common stock is that its value is backed by the value of the main company.
Tax exemptions (indirect)
Tax exemptions are one of the indirect features of common stock that are dependent on the decision of the government. The income from common stocks in some countries is not taxable. Therefore, the money earned by the common stockholder from investment or stock trading is tax exempted.
Profit and risks relation in common stocks
In the case of common stocks, the profit and risk relation is high. This means that the return from a specific stock will be high when the risk is high. While the possible return will be low if the risk is low.
When it comes to the return on stock investment, there are uncertainties. This is because the value of the stock depends on several factors such as taxes, industry factors, company earnings, or macroeconomic factors.
Common stocks tend to be more volatile than preferred stocks or corporate bonds. This is one of the features of common stock. As traders and investors trade the stock in the market, there are different people allocating different market values for the same stock. This makes the price of the stock to be volatile and that is why the price of the stock in the morning and evening of the same day may not be the same. Therefore, a share of common stock has no minimum or maximum market value and is therefore likely to change significantly in price over time.
The shares of stock are fungible which means that all the shares of a company’s common stock are worth the same amount at any given time. So, each share represents ownership of the underlying company in the same amount which means that one share of common stock could be replaced by another share without any change in value or rights.