Common shares as known as common stock, is ownership in a company, just the basic stock that is used to trading. Companies sell common shares through public offerings, and it trades among investors on the secondary market. The person who was holding the stock were hope to earn dividends from their share of company profits. However, many profitable companies do not pay dividends, and never have any intentions.(Chris Stallman, 2010) The capitalÂ stockÂ of a business entity represents the original capital paid into orÂ invested in the business by its founders. It's aÂ securityÂ for creditors since it cannot be withdrawn to the detriment of the creditors.(Wikipedia, June 2009) For example, purchase of Genting shares means ownership of the company. Common share investments are the simplest form of investment instrument. Shares are offered at a price per share agreed upon by the company and investors. Investors receive shares with the same voting rights and the same terms as founders and employees holding stock options. Common share investments offer lower legal costs, which appeals to founders/management, friends and family, and angel investors, particularly when the size of the financing round is small. However, they may not appeal to outside investors seeking better upside potential on cash invested in a business. Some investors believe that having all shareholders on an equal footing creates incentive for the company's team to perform better. Therefore, this benefit outweighs the benefits of preferred share deals that offer investors better upside potential and protection for downside risk. However, these groups are the exception rather than the rule. The obvious risk with common shares is that the price may fall but some other are different like investment vehicles, investors cannot lose more than their initial investment. The holders of common shares can reap two main benefits, capital appreciation and dividends. Capital appreciation occurs when a stock's value increases over the amount initially paid for it. The stockholder makes a profit by selling the stock at its current market value after capital appreciation. Dividends, which are taxable payments, are paid to a company's shareholders from retained or current earnings. Typically, dividends are paid to stockholders on a quarterly basis. Payments are usually made in the form of cash, but other property or stock can also be used. Payment of dividends, however, hinges on a company's capacity to grow or maintain current or retained earnings. This means ongoing payment of dividends cannot be guaranteed. Common stock has the additional benefit of enabling its holders to vote on company issues and when choosing the company's leadership. Usually, one share of common stock equals one vote. Common stock makes its holders part-owners of the issuing company. They have the right to know how their company is running and who runs it. The company sends them annual financial reports and sometimes minutes of the board of directors' meetings. These stockholders can vote for a new board of directors, and their vote is proportional to the number of shares they own. Profitable companies may decide to share their profits with stockholders by paying them dividends, but they're under no obligation to do so. If the issuing company goes into liquidation, common stockholders are the last in line, after bondholders and preferred stockholders, to get their money back.
Importance of Common Shares Stock prices along with the dividend paid on stocks are the two most important factors that affect the return on investment earned by a person investing in stocks. The market prices of the stock of any company at which the stock can be purchased and sold changes from time to time depending on number of factors. The return on investment on the stock depends on the fluctuations in price between the time of purchase and sale of the stocks by the investor. In addition, the dividend paid on the stock during this period also adds to the profit. An investor makes profit on investment when the total of the rise in price of the stock and the dividend paid is positive. The investor makes a loss when this sum is negative. Thus the investor must try and purchase and sale of stocks in such a way that stocks purchase give maximum return in form of price rise and dividend after the purchase. Also investor must try to sell off the stocks held if the market prices are likely to fall in future. As can be seen from the above discussion, an investor must be more concerned with price fluctuations of the stock rather than the absolute price to make profit by way of increase in market price. However when considering the return by way of dividend, the absolute price is also important. (Anand R. & ChungW., January 2010)
Characteristic There are three characteristics of common shares which are stock rights, uncertain returns, and value based on dividends. Stock rights is the right to receiveÂ dividend paymentsÂ typically from earnings, Â considerationÂ in a merger or other fundamental transaction and a proportionateÂ distribution of assets on corporate liquidation. The power to sell the stock (liquidity rights) and realizeÂ capital gainsÂ on public trading markets or in private transactions. Shareholders are often said to have a residual claim to the income and assets of the business. Financially, they stand last in line behind corporate creditors, such as bondholders, short-term lenders, banks, trade creditors. When a company is unable to pay its debts, and the company is forced into bankruptcy, shareholders receive nothing. (Alon Brav, February 2003)
Advantages Common shares pays less in dividends than preferred stock, and once this type of share is sold through an initial public offering, the issuing company basically has no more obligations toward the stockholders. Common stocks are highly liquid and easily transferable. The transaction costs are relatively low. The matter of its greater potential to grow in value, common stock is usually easier to sell. The investors can be bought and sold quickly at a fair price. Although past performance is not a guarantee of future performance, stocks have historically offered very high returns in relation to other investments. Common stock has the potential for delivering very large gains. The potential loss from stock purchased with cash is limited to the total amount of the initial investment, higher return due to higher risk.
Disadvantages Common stocks are risky in the term of the share prices are volatile. If the company goes bankrupt, the common stockholders will not receive their money until the creditors and preferred shareholders have received their respective share of the leftover assets. This makes common stock riskier than debt or preferred shares. The upside to common shares is that they usually outperform bonds and preferred shares in the long run. Since common stock represents ownership of a business, stockholders are the last to get paid, like all other owners. Taxes must first pay by the company to its employees, suppliers, creditors, maintain its facilities. Any money left can then be distributed among its owners. While shareholders are company owners, they do not enjoy all of the rights and privileges that the owners of privately held companies do. For example, they cannot normally walk in and demand to review in detail the company's books. Investors in a company may not know all that there is to know about the company. This limited information can sometimes cause investment decision-making to be difficult. Prices are subject to wide swings, making valuation difficult. Besides, prices can be erratic, rising and declining quickly. Such declines often cause investors to panic and sell, which actually only serves to lock in their losses. Acquisition of common stock may result in ownership control, the shareholders may lose control of the company if a person purchase shares in the market and becomes a director of the company. Stock values can sometimes change for no apparent reason, which can be quite frustrating for the investor who is trying to anticipate the stock's behavior based on the actual performance of the company.
Types of common stocks
Blue-Chip Stocks Blue-chip stocks refer to companies with a long history of sustained earnings and dividend payments. These established companies have developed leadership positions in their respective industries and, because of their importance and large size, have stable earnings and dividend records. Most companies in the Dow Jones Industrial Average are considered to be blue-chip companies. However, some financially troubled stocks such as AT&T, for example, cut their dividends and were removed from the Dow and replaced with other, more solid companies. Not all blue-chip companies are the same. For example, Wal- Mart, the largest retailer in the world, pays an annual dividend of $0.88 per share, whereas Merck, the pharmaceutical company, pays an annual dividend of $1.52 per share, and the ExxonMobil annual dividend is $1.40 per share (as of May 2007). Wal-Mart sales and earnings grew rapidly in its early years, during which time it retained its earnings to fuel its growth. In later years it began paying a small dividend. Wal-Mart does not fit into the typical definition of a blue-chip company because it does not pay much of a dividend and has not had a long history of paying out dividends. Merck and ExxonMobil historically also have had growing sales and earnings, but they have elected to pay out a higher percentage of their earnings in dividends and have longer histories of paying dividends. Blue-chip companies appeal to investors who seek quality companies with histories of growing profits and regular dividend payouts. These types of companies tend to be less risky in periods of economic uncertainty because of their dependable earnings. In bear markets, the stock prices of blue-chip companies tend to decline less than those of growth companies that do not pay dividends. Investors are attracted to blue-chip stocks because they not only provide a store of wealth in anticipation of capital appreciation but also deliver regular dividend income.
Income Stocks Income stocks have high dividend payouts, and the companies are typically in the mature stages of their industry life cycles. Stocks of companies that have established a pattern of paying higher-than average dividends can be defined as income stocks. Income stocks tend not to appreciate in price as much as blue-chip stocks do because income stock companies are more mature and are not growing as quickly as are blue-chip companies. This statement does not mean that income stock companies are not profitable or are about to go out of business. On the contrary, they have stable earnings and cash flow, but they choose to pay out much higher ratios of their earnings in dividends than other companies do. Utility companies and real estate investment trusts (REITs) are examples of income stocks. American Electric Power (ticker symbol AEP) has a current dividend of $1.56 and a dividend yield of 3.2 percent; Ameren Corporation (ticker symbol AEE) has a current dividend of $1.52 and a dividend yield of 4.7 percent; and NiSource (ticker symbol NI) has a current dividend of $0.92 and a dividend yield of 3.7 percent. These dividends and dividend yields, quoted as of May 11, 2007, were based on the stock prices on that day. The average dividend yield for stocks on the S&P 500 Index was 1.81 percent over the same period. REITs are also classified as income stocks because they are required to pass on most of their earnings to shareholders because they are pass-through entities for tax purposes.
Growth Stocks Growth stocks are issued by companies expected to have sustained high rates of growth in sales and earnings. These companies generally have high price/earnings (P/E) ratios and do not pay dividends. Companies such as Home Depot (ticker symbol HD) and Intel (ticker symbol INTC) grew at high double digits rates during the 1990s; the growth in these companies was curtailed shortly after that for different reasons. Home Depot faced increased competition from Lowe's, which has newer, smaller, and more manageable stores. Intel saw sharp declines in its sales because of reductions in capital equipment spending by business, a decline in computer replacement sales by consumers, and increased competition from Advanced Micro Devices. Nevertheless, Intel still managed to keep its gross profit margins above 50 percent for most quarters during the first half of the 2000 decade. An indication that these two companies have passed through their sustained high-growth periods is that they no longer retain all their earnings. Both pay out small amounts of their earnings in dividends. In addition, because of their leadership positions in their respective industries, they also could be classified as blue-chip companies. Most growth companies pay no dividends, such as Cisco Systems (ticker symbol CSCO), which saw annual sales growth in the 30 to 50 percent range during the 1990's technology boom. Cisco's stock price soared around 130,000 percent from its initial public offering (IPO) in February 1990 to March 2000. Cisco expects growth to continue in the high single digits to low teens for revenue and earnings over the next five years. Rather than pay out their earnings in dividends, growth companies retain their earnings and reinvest them in the expansion of their businesses. Google is a good example of a growth company with a price to- earnings ratio of 71. Investors are willing to buy Google at $404 per share, paying 71 times earnings of $5.70 per share. Growth stocks are often referred to as high P/E ratio stocks because their greater growth prospects make investors more willing to buy them at higher prices. Investors do not receive returns in the form of dividends, so they buy these stocks for their potential capital appreciation.
Cyclical Stocks Cyclical stock prices move with the economy. Cyclical stocks often reach their high and low points before the respective peaks and troughs of the economy. When the economy is in recession, these stocks see a decline in sales and earnings. During periods of expansion, these stocks grow substantially in sales and earnings. Examples of cyclical stocks are stocks issued by capital equipment companies, home builders, auto companies, and companies in other sectors tied to the fortunes of the economy as a whole. The economic growth in 2005-2006 has seen the stocks of John Deere (ticker symbol DE), the farm equipment maker, and Cummins Engine (ticker symbol CMI), the diesel engine manufacturer, rise to their 52-week highs. During a recession, stocks of this type are beaten down and are considered value stocks for patient investors who are willing to buy them and hold them until the next economic turnaround. Cyclical stocks appeal to investors who like to trade actively by moving in and out of stocks as the economy moves through its cycle.Â
Speculative Stocks Speculative stocks have the potential for above-average returns, but they also carry above-average risk of loss if the company does poorly or goes bankrupt. Speculative stocks are stocks issued by companies that have a small probability for large increases in the prices of their stocks. These companies do not have earnings records and are considered to have a high degree of risk. In other words, these companies are quite likely to incur losses and not as likely to experience profits, so they have a higher possibility of larger price gains or losses than other types of stocks. Speculative stocks are more volatile than the other stock types. Speculative stocks are often issued by new companies with promising ideas that are in the development stages. With oil above $70 per barrel in 2006, the stocks of many alternative energy companies with low sales and no earnings rose to high prices with investors speculating on their potential relevance in providing alternative sources of energy. The requisite quality for buying speculative stocks, because of their high risk, is a strong stomach-you have to be able to sleep well at night under any circumstances. These stocks deliver either large capital gains or large capital losses.
Recommendation After the investment instrument we go through, we recommend that common stock (common shares) is a better share that investor may invest in, the main reason is that common share is easy to trade with the lower trading cost. Besides, common shares is no limit in capital gains potential, investor will invest in risky assets to receive a higher returns. Common shares can be invest by publics so that the investors can be bought and sold quickly at a fair price. The common shareholders are allowed to vote to the company on the important matters, the power of voting is depending the number of shares that held by the shareholders. So, we'll recommend that common shares is a better choice to invest by the investor.
Conclusion A company may find it easier to sell common stock because of its potential to grow higher than preferred stock. It is no maturity date that will be held in perpetuity which means it can be passed down to the next kin. The business has to bear in mind, however, that common stockholders have voting rights, which is not the case with preferred stockholders. With common stock, there's no obligation to pay dividends, while with preferred ones, whether or not dividend payments are made depends on the type of stock issued. Finally, if a company becomes profitable and wants to buy back some of the stock, it will find it cheaper to do so with preferred stock than with common stock. (2889 words)