Investing in stock is a great way to diversify your portfolio and potentially build wealth. Most investors tend to buy common stock. That security grants the stockholder partial equity ownership of a corporation. Here’s a breakdown of the ins and outs of common stock and why investors choose them.
Consult a financial advisor to learn more about the various types of equity and fixed-income securities that may be a good fit for your portfolio.
What Is a Common Stock?
Common stock represents partial ownership of a public company or corporation. Each share represents of a portion of ownership of a specific company. Generally, most investors purchase this type of stock.
If a company does well or the value of the shares increases, the value of the common stock increases as well. However, if the company doesn’t thrive, common stock shares may decrease in value. Essentially, investors can capitalize on the growth and success of a company. That tends to make common stock a good long-term investment.
Common stock also comes with voting rights. Shareholders can vote on everything from corporate directors to policy changes to stock splits. However, some companies may have two classes of stock, which include voting and non-voting shares.
Also, depending on a company’s profitability they may decide to pay their shareholders dividends or a portion of their profits. For instance, let’s say company ABC Corporation declares a $20 million profit to its 40 million shareholders. That means each shareholder would receive $0.50 for each share they own.
Common Stock Basics
If a company wants to issue stock, it will hold an initial public offering or IPO. To begin this process, a company will partner with an underwriting bank. The bank determines the type of stock and pricing. Once this phase is complete, the general public can purchase shares of this new stock on a secondary market. Conducting an IPO is a good way for the company to receive additional capital so they can expand and grow.
The New York Stock Exchange (NYSE) and NASDAQ are two of the most common public exchanges that trade larger U.S. based stocks. As of 2019, the NYSE trades stocks for about 2,800 companies ranging from blue-chips to high-growth companies. Meanwhile, NASDAQ trades about 3,300 company stocks.
There are several international stock exchanges as well. These exchanges include the Tokyo Stock Exchange and the London Stock Exchange. All companies may not meet listing requirements for an exchange. If this is the circumstance, the company can list themselves on pink sheets or the Over The Counter Bulletin Board (OTCBB).
Common stock shareholders have the least priority in regards to the ownership structure of shares. For example, if a company liquidates or goes bankrupt, preferred stock shareholders, bond holders, and other debt holders receive payment before common shareholders. As a result, this makes common stock a more risky investment endeavor than debt or preferred stock shares. However, common stock shares often perform better than debt and preferred stocks in the long-term.
Types of Common Stock
There are generally two types of stock: common stock and preferred stock. While common stock shareholders may have voting rights, preferred stock shareholders typically don’t have voting rights. Also, preferred stockholders have priority over common stockholders when it comes to dividends or company assets if it goes bankrupt.
Usually, common stock and preferred stock fall into one or more of the following stock categories.
- Growth stocks usually grow at a faster rate than the market average. Growth stocks don’t usually pay dividends, so investors buy them to capitalize on the share’s appreciation. For example, a technology start-up may be categorized as a growth stock.
- Income stocks regularly pay dividends to shareholders. Investors tend to purchase income stocks if they want to increase their cash flow. An example of an income stock may be a reputable utility company.
- Value stocks may be either income or growth stocks. They tend to have a lower price-to-earnings (PE) ratios, which means they are cheaper than stocks with higher PEs. The lower PE means that investors no longer favor them. That said, investors may purchase these stocks in hopes the price will rebound.
- Blue-chip stocks are shares of companies that have a solid growth history and generally pay dividends.
Common shares can also classify as large-cap, mid-cap, and small-cap stocks. Essentially, this is a reference to the size of the company. For companies that are very small, they may categorize as micro-cap stocks. And the lowest-priced stock is penny stocks, which may have little to no earnings.
Why Do Investors Buy Stock?
Many investors consider common stock an important component to a well-diversified portfolio. While common stock may bear more risk than a CD, bond or other fixed-income security, they can come with the potential for a greater reward. Stocks tend to outperform many other long-term investments. However, in the short-term they can be more volatile.
It’s also important to note that there is no guarantee that a company’s stocks will grow and succeed. Therefore, it’s possible to lose all of the money you invest in any common stocks.
The Bottom Line
Buying common stock is an integral part of many investors’ financial plans. While common stock comes with some risk, they give investors potential for growth. Before you find a broker and actually buy the stocks, make sure you’ve gone over your finances. Also, know which stocks you want to buy that will help you achieve your financial goals.
- A financial advisor can help you get into stock investing. If you don’t have a financial advisor yet, finding one doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- You’re going to want a diversified portfolio. This means that your investments range from different kinds of stocks to various bonds and more. You can determine your own asset allocation based on your risk tolerance and time horizon.
Photo credit: ©iStock.com/Bluberries, ©iStock.com/Yozayo, ©iStock.com/Bet_Noire