What is Common Stock?

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Definition:

Common stock is a breed of stock that gives investors ownership in a company, usually with some voting rights.

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🤔 Understanding common stock

Common stock is a major type of security that represents a portion of ownership in a company. Common stock often has perks like giving investors the right to vote for a company’s board of directors or even votes in decisions to change corporate policies. But, common stock has its caveats, like how owning shares can sometimes be riskier than owning bonds. Common shares are also different from preferred shares, which put investors first in line to receive income (aka dividends), based on how many preferred shares they own. Common stockholders can sometimes also earn this dividend income, but only after preferred shareholders have been paid theirs.

Example

The most commonly traded stocks are issued by publicly traded companies. Private companies, including startups, also have common shares, but they tend to be owned by a small number of founders and investors.

Takeaway

Common stock is like general admission at a concert, while preferred shares are like VIP passes...

Both types of stock represent ownership in a company, but common stock typically comes with voting rights (whereas preferred stock does not). Some common stocks also come with perks like income paid back to shareholders (aka dividends). However, preferred stock shareholders have a prioritized spot in line, receiving dividends before common stockholders do and their dividends are generally larger.

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The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.

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What are the characteristics of common stock?

Common stock has a few key features :

  1. Availability: It’s the most common way investors get to own part of a company.
  2. Voting rights: These shares usually come with voting rights that give investors a say in some of the decisions like selecting members to a board of directors, as well as certain corporate events, like mergers, acquisitions, or stock splits.
  3. Dividends... maybe: Not every company doles out dividends. But, when companies do, there’s a chance common stockholders can get them — after preferred shareholders have been paid.

What’s the difference between common stock and preferred stock?

Common stock and preferred stock both give investors the chance to own part of a company. But like the name suggests, preferred stock comes with some perks:

  1. Dibs on dividends: If a company pays dividends, preferred shareholders get paid first, before common stock shareholders see any dividend money that might be leftover. If a company ends up suspending its dividend, the dividends intended for preferred shareholders accumulate. If the company reinstates its dividends, the preferred shareholders get paid first, before common stockholders get a penny. Common stockholders do not accumulate any missed dividends.
  2. Dividend amount: The dividend paid to preferred shareholders is fixed (similar to how the interest payment on a bond is fixed), while the dividend paid to common stockholders is variable, changing based on the decisions of the company’s managers.
  3. Less risk: If a company goes under, preferred shareholders have a prioritized claim on the company’s remaining assets relative to common stockholders (assuming there’s any money left at all and after creditors are paid).
  4. Share class conversion: Preferred stockholders sometimes have the opportunity to convert their preferred shares into common stock, which is known as convertible preferred stock. It’s a flavor of stock that means that in the future, either the owner of the stock, the company’s board of directors, or the company, on a planned date could convert the preferred shares into common shares.

How is the book value of common stock calculated?

On balance sheets, common stock is typically reported in the shareholders’ equity section. It appears on balance sheets along with other types of stock such as preferred stock and treasury stock. Treasury stock is usually a corporation's previously issued shares of common stock that have been purchased from the stockholders, but the corporation has not retired the shares. The value of common stock is calculated by dividing the total common stockholders’ equity minus preferred stockholders’ equity by the average number of common shares outstanding. Accountants and financial analysts call this “book value.” The book value of common stock rarely matches the market value of common stock. The market value is driven by stock market investors; book value is driven by the assets of the company and accounting.

What’s the history of common stock?

Some of the first known “common stock” was created about 400 years ago by the East India Company in 1602, debuting on the Amsterdam Stock Exchange. In the US today, common stocks are most frequently traded on the New York Stock Exchange and the Nasdaq, the two biggest stock exchanges in the world.

Why does a company issue common stock?

Both private and public companies typically have common stock. However, within private companies, common stock of private companies is typically reserved for founders, investors, and even some employees. When private companies become public, they can go through an initial public offering (IPO) in which they similarly sell shares in exchange for raising cash — But then their shares are publicly available to be traded.

For companies, issuing more common stock (aka making more common shares available) or going through the IPO process can be a means of raising money, and an alternative to taking on debt. Companies can use money from selling common shares to invest in their growth, pay off their debts, buy another company, or simply keep more cash on hand. Issuing common stock can be an attractive alternative to taking on debt, because instead of getting stuck paying interest on debt, companies can pay dividends to common shareholders instead when they have the cash — the catch is that by selling its stock, a company is selling part of its ownership (potentially even voting rights) of itself. And selling stock dilutes the ownership of all the other stock, kind of like cutting 1 pizza into 8 slices instead of 6.

How can an investor buy common stocks?

Common stocks can be purchased on the public markets, as well as through private marketplaces (FYI, private markets are less flexible, less accessible, and less easy to buy or sell compared to public markets). In public markets, stocks can be bought and sold throughout the day on stock exchanges. Most often, investors buy stock through a traditional broker, an online broker or even sometimes directly from the company.

Ready to start investing?
Sign up for Robinhood and get your first stock on us.Certain limitations apply

The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.

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