While the word "common" sounds rather ordinary, common stock is the type of stock most people invest in. So, when you read reports about a company's share prices, this is usually what they mean. Common stockholders own a share in the company and have the opportunity to make huge returns on their investment if the company does well. Companies sell or issue common stock to get the company up and running, or to raise the capital they need to grow.
What Is Common Stock?
Common stock represents a single share of ownership in a company. There are unique advantages associated with owning common stock, including voting rights on matters that require shareholder approval and the possibility of dividends if the company turns a profit. For example, if a company declares a dividend of $500,000 and there are one million shareholders, investors will receive $0.50 for each common share they own. If the company becomes successful, a common stock typically will increase in value – sometimes considerably. Common stock represents an opportunity for investors to share in a company's success over time, which is why they are such popular long-term investments.
Why Do Companies Issue Common Stock?
Issuing common stock is a way for the company to raise money. It can use that money to get off the ground, expand, buy additional property or machinery, pay debts, buy another company or simply to finance daily operations. In this respect, issuing common stock is a good alternative and much less expensive than taking on debt. With stock, the company does not have to make monthly interest payments. The board has the discretion to make dividend payments only when the company has extra cash.
Common Stock Versus Preferred Stock
With common stock, dividends can go up or down depending on the company's cash flow. The board does not have to declare a dividend if the cash is needed elsewhere. The other main type of stock, preferred stock, works a bit differently. With preferred stock, companies must pay out a stable, guaranteed dividend at regular intervals even when there's no dividend available for common stockholders. If the company misses a payment, it must make the debt up to preferred shareholders at a later date. Owners of preferred stocks have no voting rights and less control over corporate decision making. Companies issue preferred stock as a way to raise money without giving away control of the company.
Common Stock Examples
When a company incorporates, it will specify the number of common shares it is authorized to issue and the "par value" of those shares. The par value represents the lowest price the shares can sell for and is hardly ever the same as a share's market value. Most companies set a nominal par value of a few cents per share as required by state law. When a company sells some of its authorized common stock, the shares are described as "issued." A final category of shares is "outstanding" common shares. This represents the number of common shares that have been purchased by investors and are floating around the open market.
Information regarding the authorized shares, issued shares, outstanding shares and par value must be reported on the company's balance sheet. Where the company issues shares above par value, this will be shown as the "capital surplus." For example, if a company's common stock has a par value of $0.01 and it issued at a share price of $10, the capital surplus is $9.99 per share. Together, these figures show the total value of shareholder's equity, or how much stake in the company the common stockholders own.
When Things Go Wrong
In the hierarchy of company ownership, common stockholders are the bottom rung of the ladder. When the company does poorly, for example, the value of the shares could drop all the way down to zero in some circumstances. Common stockholders are also the last in line to get paid if the company goes bankrupt, and there may not be any cash left in the pot to pay them out after secured creditors, bondholders and preferred stockholders have taken their cut. Investors accept these risks in exchange for potentially greater gains than safer investments such as Treasury bonds can offer.