Stocks is an instrument that signifies an ownership position (called equity) in a corporation, and represents a claim on its proportional share in the corporation’s assets and profits.It represent shares of ownership in a company. A company can issue several classes of stock, and they are grouped into either the common stock class or preferred stock class. Each class has its advantages and disadvantages depending on what you are looking for as an investor.
Common Stock
Common stock is the basic type of stock that a company issues. There are no restrictions on who can buy common stock. Common stocks represent ownership in the company and entitle shareholders to vote on proxy items presented at a company’s annual shareholders’ meeting.
Why Invest In Common Stock?
In order to have a say in how the company is run, you must own common stock. When individual investors or groups of investors (for example, institutional investors) attempt to influence company policy or attempt a hostile takeover, they must be shareholders in that company. Common stock does not have any guaranteed dividends; instead, investors hope that the company will pay larger dividends from the profits. Since common shares do not guarantee returns, these shares are more responsive to the performance of the company. Similarly, the growth potential is greater because there is no cap on the dividends that can be paid out if the company does very well. However, with common shares there is also the added risk of losing the entire investment because common stockholders are generally paid only what’s left after everyone else takes their share when a company goes out of business.
Different Classes of Common Stock
Sometimes companies will issue multiple classes of common stock with different voting rights. For example, class A shares might have 1 vote per share, class B shares might have 10 votes per share and class C shares might have 20 votes per share. The well-known company, Berkshire Hathaway, has two classes of common stock–class A and class B–and class B has 1/200th the voting power of class A.
A company may choose to issue multiple classes of stock to keep the voting power concentrated in the founders’ hands. For example, if a partnership of three founders were to take their company public, they may sell many common shares that only carry one vote per share, but retain for themselves a second class of stock that represents the same ownership in the company but has 100 votes per share to protect themselves from losing control of the company.
Preferred Stock
Preferred stock is a type of stock that has certain advantages over common stock. Most preferred stock shares are promised a dividend payment while common shares are not. Preferred stock also has the right to the assets of the company before common shareholders should it go bankrupt. Preferred stock, however, does not have voting rights.
Why Invest in Preferred Stock?
Preferred stock is more secure than common stock because it has priority should the company go bankrupt. However, it has less potential for growth and no voting rights, so it will generally provide lower returns than common stock. Preferred stocks are also more likely to receive dividends which provides a guaranteed return on the investment. However, if you have no aspirations of owning the company and are looking for a stable investment, preferred stock may be a good option.
P.S Note: Usually, common stocks cannot be paid a dividend before the promised dividend is paid to the preferred stock.