Stock Shares: Working Mechanism, Categories, Characteristics, Benefits, and Drawbacks
Stock Ownership 101: Common stock, the kind most frequently seen in stock markets, stands for ownership in a corporation. If you own some, you're essentially a part-owner of the company, entitled to a piece of the profits and a say in key decisions, within limits.
Unlike preferred stock, common stock often comes with voting rights. The number of votes you get depends on how much stock you own and the class you hold. Class A shares, for example, might give you more voting power than other classes. You acquire these shares on a stock exchange, usually through an Initial Public Offering (IPO) when companies offer their shares to the public.
Corporate actions, like stock splits or dividends, affect the number of shares available for purchase. For instance, stock splits increase the number of shares, making them more affordable for individual investors, while dividends are profit payouts to shareholders.
Not every corporation offers common stock to the public. Private companies, like startups, typically sell their shares to accredited investors only.
How Do Common Stocks Function?
Common stocks are cost-effective yet risky investments. They represent fractional ownership of the company, and revenues are shared among many investors. Each share secures a claim on the company's profits, and shareholders are entitled to dividends when management decides to distribute them.
Common shares frequently come with voting rights, empowering shareholders to influence the company's direction through voting during shareholder meetings. However, their impact is significant only if they hold a substantial stake.
Why Companies Issue Shares
Despite sharing control with investors, corporations issue shares to raise funds. Big names like Apple, Alibaba, Amazon, Alphabet, Microsoft, Tesla, and Meta sell shares to gain access to vast resources. For instance, Apple raised more than $100 million from its IPO in 1980 by selling 4.6 million shares at $22.00 each. Similarly, Alibaba Group Holding Limited raised $22 billion through IPOs in 2014.
By issuing shares, companies can also reduce their financial leverage. Debt securities, like bonds, have future financial obligations, while shares do not. Companies must regularly pay coupons on bonds and repay the principal at maturity. Failing to do so leads to default. High financial leverage causes a higher risk of default and difficulty obtaining new loans at reasonable interest rates.
On the other hand, shares do not have default consequences. They represent ownership rights, not debt, so no regular payments are required. Hence, issuing shares increases equity without adding financial leverage.
Consequences of Stock Sales for Companies
When companies issue common stock, the ownership structure changes. If the shares are primarily owned by a few parties before the IPO, like founders, more investors can buy them after the IPO, becoming shareholders.
For instance, if a company has 100 outstanding shares and sells 90 at the IPO, 90 new shareholders own 1% of the company each. Further stock issuances increase the number of outstanding shares, diluting existing shareholder holdings. As a result, one share no longer represents 1% ownership but a lower percentage.
Common Stocks vs. Preferred Stocks
Preferred stocks behave differently from common stocks. While common stocks come with voting rights, preferred stocks rarely do, unless they are explicitly issued that way. Though they lack voting rights, preferred stockholders enjoy priority in receiving dividends and higher dividend rates. They also have a higher priority to claim assets in liquidation.
Classes of Common Stocks
A single corporation can issue different classes of common stock, each with varying voting rights and distributions during liquidation. For example, Google's classes consist of Class A, Class B, and Class C shares. Class A shares have one vote per share, while Class B shares have ten votes per share. Class C shares have no voting rights.
Callable and Puttable Features
Some common stocks contain callable and puttable features. Callable stocks enable companies to repurchase shares from investors when they deem fit. This feature benefits companies by allowing them to buy back shares at a lower price when their stock price appreciates, saving on future dividend payments.
Puttable stocks, conversely, allow investors to resell their shares to the issuing company. This feature saves investors from losses when the stock price dips significantly, allowing them to sell their shares back to the company at a predetermined price.
Are Common Stocks a Wise Investment?
Investing in common stocks offers the potential for capital gains, regular dividends, and influence over key decisions through voting rights. However, it also carries higher risks compared to fixed-income investments due to the stock's volatility. Not all companies pay regular dividends, and the amount of voting rights depends on the class of stock and the size of the shareholder's stake.
Despite the risks, common stocks are an appealing investment option for those seeking high returns and the opportunity to reap the benefits of a company's success.
In the realm of finance and business, common stocks are cost-effective yet risky investments that offer fractional ownership in a corporation. By investing in common stocks, investors enable corporations to raise funds for expansion, as demonstrated by companies like Apple and Alibaba.
Each common stock secures a claim on the company's profits, providing shareholders with the potential for regular dividends. Furthermore, common stocks often come with voting rights, allowing shareholders to exercise influence over key decisions within the corporation. However, the impact of these votes is significant only when a substantial stake is held.
