Common Stock: Definition, Rights, Risks, and How to Invest

Key takeaways
* Common stock represents basic ownership in a corporation and usually carries voting rights.
* Common shareholders share in profits via dividends (when declared) and benefit from capital appreciation, but are last in line in a liquidation.
* Preferred stock has priority for dividends and asset claims but typically lacks voting rights and offers lower upside potential.
* Investors should choose between common and preferred stock based on return goals, income needs, and risk tolerance.

What is common stock?

Common stock is a security that represents a residual ownership stake in a corporation. Holders of common shares:
* Have a claim on a portion of the company’s earnings and assets (after creditors and preferred shareholders are paid).
* Usually have voting rights to elect the board of directors and approve major corporate actions.
* May receive dividends when the board decides to distribute earnings.

Common shares are traded on public exchanges (NYSE, Nasdaq, and others) or over the counter for smaller/unlisted companies.

Rights and risks of common shareholders

Rights
* Voting on corporate matters (typically one vote per share, though multiple classes can exist).
* Potential to receive dividends.
* Participation in long-term capital appreciation.

Risks
* In bankruptcy or liquidation, common shareholders are paid after creditors, bondholders, and preferred shareholders.
* Dividends are not guaranteed and can be reduced or eliminated.
* Share prices can be volatile in the short term.

Common stock vs. preferred stock

Similarities
* Both represent ownership in a company and can be bought and sold on markets.

Key differences
* Voting: Common stock typically grants voting rights; preferred stock generally does not.
* Dividends: Preferred stock usually pays fixed dividends and has priority over common stock for payment. Some preferred shares are cumulative, meaning missed payments accrue.
* Claim on assets: Preferred shareholders have a higher claim than common shareholders in liquidation.
* Volatility and returns: Common stock usually offers higher long-term upside but greater price volatility; preferred stock offers steadier income with lower upside.
* Liquidity: Common stocks are typically more liquid and traded more frequently than preferred shares.

Other features of preferred stock
* Callable preferred: Issuer can repurchase shares at a set price/time, which may limit future income.
* Convertible preferred: Can be converted into common shares under specified terms, offering potential upside if common shares rise.

How stocks are issued and traded

• Initial Public Offering (IPO): A company issues stock to the public to raise capital. Underwriters set terms and price.
• Secondary market: After an IPO, shares are traded among investors on exchanges or OTC.
• Market cap categories: Stocks are often classified as large-, mid-, or small-cap, reflecting company size and typical risk/volatility profiles.

Types of common stock and investment styles

• Growth stocks: Companies expected to grow earnings rapidly; often reinvest profits rather than pay dividends. Higher potential appreciation, more volatility.
• Value stocks: Priced lower relative to fundamentals; often pay dividends and may be less volatile.
• Class shares: Some companies issue multiple classes with different voting rights (e.g., dual-class structures).

How to invest in common stock

1. Set goals and risk tolerance: Decide whether you want growth, income, or a combination.
2. Research companies: Review financials, competitive position, management, and industry outlook.
3. Consider diversification: Spread investments across sectors, market caps, and asset classes to manage risk.
4. Choose an account and broker: Use a brokerage account, retirement account, or robo-advisor according to your needs.
5. Monitor and rebalance: Periodically review holdings and adjust to maintain your allocation.

How to invest in preferred stock

• Evaluate the issuer’s creditworthiness—preferred stock carries issuer risk similar to common stock.
• Check dividend yield relative to price and compare across issues.
• Note special features: callable or convertible terms can affect income and upside potential.
• Understand liquidity and trading frequency—preferred shares can be less liquid than common shares.

Voting and proxy voting

• Most common shares offer one vote per share for matters like board elections, mergers, and significant corporate actions.
• If you cannot attend a shareholder meeting, you can vote by proxy—authorizing someone else to vote on your behalf.

Pros and cons (summary)

Common stock
* Pros: Greater potential long-term returns, voting rights, high liquidity.
* Cons: Higher volatility, dividend uncertainty, lower priority in liquidation.

Preferred stock
* Pros: Priority for dividends, fixed income-like payments, lower volatility.
* Cons: Usually no voting rights, lower upside potential, less frequently traded.

Explain like I’m five

Common stock is like owning a small piece of a company. If the company does well, your piece becomes more valuable and you might get part of the profits. But if the company runs into big trouble, people who lent the company money get paid first, and you might get little or nothing. Preferred stock is another kind of piece that usually pays steady income but doesn’t usually let you vote.

Bottom line

Common stock is the primary way retail and institutional investors gain ownership exposure to companies, offering voting rights and the potential for significant long-term returns. However, it carries greater short-term risk and lower priority in a liquidation compared with preferred stock and debt. Choose the type of stock that matches your investment goals, income needs, and tolerance for volatility.