Definition of 'Common Stock'

A security that represents ownership in a corporation. Holders of common stock exercise control by electing a board of directors and voting on corporate policy. Common stockholders are on the bottom of the priority ladder for ownership structure. In the event of liquidation, common shareholders have rights to a company's assets only after bondholders, preferred shareholders and other debt holders have been paid in full.

Common Stock
Common stock is ownership in a company, just the basic stock that we're used to trading. Companies sell common stock through public offerings, and it's traded among investors on the secondary market. Those who hold the stock hope to earn dividends from their share of company profits. However, many profitable companies don't pay dividends, and never have any intentions of doing so (i.e. Microsoft). The obvious risk with common stock is that the price may fall. Unlike some other investment vehicles, investors cannot lose more than their initial investment. Common shareholders are not guaranteed a dividend payment, preferred shareholders enjoy a fairly fixed dividend and are paid before a company decides whether it can pay its common shareholders. When a company makes a profit (after tax), retained earnings may be distributed to shareholders(owners of common stock) as dividends. This dividend distribution depends upon whether the company is making a profit. Shares of stock are given to owners of corporations as evidence of their ownership interests. The ownership of common shares allows common stockholders to vote for the board of directors, receive dividends, and receive assets when the corporations go out of business. The sale of common stock to owners is a source of resources for a corporation. In return for the common shares, the corporation receives resources from the buyer, who becomes an owner. The capital stock (or simply stock) of a business entity represents the original capital paid into or invested in the business by its founders. It's a security for creditors since it cannot be withdrawn to the detriment of the creditors. Most shares of stock are called "common shares". If you own a share of common stock, then you are a partial owner of the company. You are also entitled to certain voting rights regarding company matters. Typically, common stock shareholders receive one vote per share to elect the company's board of directors (although the number of votes is not always directly proportional to the number of shares owned). The board of directors is the group of individuals that represents the owners of the corporation and oversees major decisions for the company. Common stock

shareholders also receive voting rights regarding other company matters such as stock splits and company objectives. In addition to voting rights, common shareholders sometimes enjoy what are called "preemptive rights." Preemptive rights allow common shareholders to maintain their proportional ownership in the company in the event that the company issues another offering of stock. This means that common shareholders with preemptive rights have the right but not the obligation to purchase as many new shares of the stock as it would take to maintain their proportional ownership in the company. But although common stock entitles its holders to a number of different rights and privileges, it does have one major drawback: common stock shareholders are the last in line to receive the company's assets. This means that common stock shareholders receive dividend payments only after all preferred shareholders have received their dividend payments . It also means that if the company goes bankrupt, the common stock shareholders receive whatever assets are left over only after all creditors, bondholders, and preferred shareholders have been paid in full.

Features of Common Stock

Stock rights Common stock represents a bundle of rights and powers. They include: the right to receive dividend payments typically from earnings -- if authorized by the board of directors the power to sell the stock (liquidity rights) and realize capital gains on public trading markets or in private transactions-- if there are willing buyers the right to receive consideration in a merger or other fundamental transaction -- if approved by the board and the shareholders the right to vote to elect directors and to approve fundamental transactions (mergers, sale of assets, amendments to articles, dissolutions) the right to receive a proportionate distribution of assets on corporate liquidation -- if the board and shareholders approve a dissolution 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. There are other kinds of ownership interests. For example, preferred stock has a prior and often fixed claim to dividends and distributions, but typically lacks the power to elect directors or vote on fundamental corporate transactions. Often seen as a hybrid between debt and common stock, preferred has characteristics of both. Similar to debt, preferred stock offers a fixed dividend, but usually no voting

rights unless the company stops paying dividends. Similar to equity, preferred has no maturity and the firm does not go bankrupt if it cannot pay dividends. It is possible to have non-voting stock, which has all the financial rights of common stock, but lacks the power to choose directors or veto corporate transactions.

Uncertain returns As you can see, the returns on common stock are uncertain. The company might not have earnings with which to pay dividends. The board might not declare dividends, but instead reinvest earnings in the company. There may not be a market into which to sell stock. The market might, because of structural or informational flaws, not value stock effinciently. The board might approve a merger that imposes a price that does not reflect the stock's future return potential. The board might approve a dissolution and liquidation of the company's assets at a price that does not reflect the company's ongoing business value. Value based on dividends Professional stock valuators focus on cash dividends. Why is this? Some companies do not pay dividends, and most companies pay less in dividends than has been earned. In addition, many shareholders realize returns when they sell the stock (capital gains) or receive a higher price in a fundamental corporate transaction, such as a merger. In the end, stock has value because of the possibility of cash returns: Earnings. Even if current earnings are retained and reinvested, the reinvested earnings should produce future earnings that eventually will be paid as dividends. Capital gains. If a shareholder sells stock on the market, it is because the buyer values the potential for future returns - that is, dividends. Merger. If a company is acquired in a merger, and its shareholders paid for their stock, the acquirer values the company's potential for creating returns - dividends. For this reason, professional stock valuators say that only dividends are relevant. But stock markets are more realistic about human nature. Market traders know, for example, that stock prices in mergers often involve more than the acquirer's valuation of future dividends. Sometimes the acquirer's managers have big egos and just want to run a bigger business! The selling shareholders know this and will demand a higher merger price.

Advantages Common stock has the potential for delivering very large gains, unlike bonds, Certificates of Deposit, or some other alternatives. Annual returns-on-investment (ROIs) of over 100% have occurred on a somewhat regular basis. The potential loss from stock purchased with cash is limited to the total amount of the initial investment. This is considerably better than that of some leveraged transactions, where the maximum loss can well exceed the total of the funds invested. Stocks offer limited legal liability. Passive stockholders (those who take no active part in the running of the company) are protected against any liability stemming from the companys actions beyond their financial investment in the company. Most stocks are very liquid; in other words, they 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. Stocks offer two ways for their owners to benefit, by capital gains and with dividends. As previously stated, each share of stock represents partial ownership in a company. If the company becomes more valuable, so will the ownership interest represented by each share of stock. This appreciation of the stocks value is known as a capital gain. In addition, if the company earns more profits than it needs to support its maintenance and growth, it may elect to distribute the excess to its owners, the shareholders. The periodic distributions of profits are called dividend payments.

Disadvantages Since common stock represents ownership of a business, stockholders are the last to get paid, like all other owners. A company must first pay its employees, suppliers, creditors, maintain its facilities and pay its taxes. 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 companys 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. Stock prices tend to be volatile. 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. Stock values can sometimes change for no apparent reason, which can be quite frustrating for the investor who is trying to anticipate the stocks behavior based on the actual performance of the company.

Preferred stock
A second type of stock, which a company may choose to issue, is preferred stock. Preferred stock is listed separately from common stock and trades at a different price. Unlike common stockholders, preferred stockholders are not usually entitled to voting rights, but they do have a higher claim on assets and earnings than do common shareholders. A class of ownership in a corporation that has a higher claim on the assets and earnings than common stock. Preferred stock generally has a dividend that must be paid out before dividends to common stockholders and the shares usually do not have voting rights. Preferred shares, preference shares, or simply preferred, is a special equity security that has properties of both an equity and a debt instrument and is generally considered a hybrid instrument. Preferred are senior (i.e. higher ranking) to common stock, but are subordinate to bonds in terms of claim or rights to their share of the assets of the company. Preferred stock usually carries no voting rights, but may carry a dividend and may have priority over common stock in the payment of dividends and upon liquidation. Terms of the preferred stock are stated in a "Certificate of Designation". Similar to bonds, preferred stocks are rated by the major credit rating companies. The rating for preferred is generally lower since preferred dividends do not carry the same guarantees as interest payments from bonds and they are junior to all creditors. On the other hand, if the company does increasingly well, dividends for preferred shareholders are unlikely to increase as earnings increase, while a common shareholder could benefit from higher dividend payments. Preferred stock or "preferred securities" share many characteristics of both a stock and a bond. Like bonds, they have a relatively high fixed-rate payment. Like common stock, they are generally listed on a stock exchange. A preferred stock is an equity that may or may not have maturity. A preferred can either pay a dividend or interest, usually quarterly or semiannually, and it represents a non-voting ownership in a company. These securities are called "preferred" because preferred shareholders have superior rights to assets and cash flows of a

company versus common shareholders in the event of a bankruptcy or liquidation; however, bondholders' claims are senior to those of preferred shareholders. Like common stock, preferred stock is sold by companies and is then traded among investors on the secondary market. Preferred stock is less risky than common stock, therefore investors can expect less reward. In many ways preferred stock works like bonds. While bonds guarantee regular interest payments, preferred stock guarantees regular dividend payments for a specified time. Preferred stock price is less volatile than common, and virtually eliminates the possibility of large capital gains. Preferred stock is rated in a similar fashion to bonds as well. Standard & Poor's ratings range from AAA (best) down to D (worst). These ratings help investors make judgments as to whether the underlying company will be able to pay dividends. Should the company default on dividends and declare bankruptcy, preferred stock holders are entitled to assets before common stock holders. The bottom line is that preferred stock is less risky than common stock. It's designed to provide an income generating opportunity for investors while raising capital for the underlying company. As Buck investors, we probably shouldn't be thinking about preferred stock until we approach retirement in 30 years, but it's good to know the difference. First preferred stock have a greater claim to a company's assets and earnings. This is true during the good times when the company has excess cash and decides to distribute money in the form of dividends to its investors. In these instances when distributions are made, preferred stockholders must be paid before common stockholders. However, this claim is most important during times of insolvency when common stockholders are last in line for the company's assets. This means that when the company must liquidate and pay all creditors and bondholders, common stockholders will not receive any money until after the preferred shareholders are paid out. Second, the dividends of preferred stocks are different from and generally greater than those of common stock. When you buy a preferred stock, you will have an idea of when to expect a dividend because they are paid at regular intervals. This is not necessarily the case for common stock, as the company's board of directors will decide whether or not to pay out a dividend. Because of this characteristic, preferred stock typically don't fluctuate as often as a company's common stock and can sometimes be classified as a fixed-income security. Adding to this fixedincome personality is the fact that the dividends are typically guaranteed, meaning that if the company does miss one, it will be required to pay it before any future dividends are paid on either stock. Like common stock, preferred stock represents partial ownership in a company, although preferred stock shareholders do not enjoy any of the voting rights of common stockholders. Also

unlike common stock, preferred stock pays a fixed dividend that does not fluctuate, although the company does not have to pay this dividend if it lacks the financial ability to do so. The main benefit to owning preferred stock is that you have a greater claim on the company's assets than common stockholders. Preferred shareholders always receive their dividends first and, in the event the company goes bankrupt, preferred shareholders are paid off before common stockholders. Features of preferred stock:

Preferred stock is a special class of shares that may have any combination of features not possessed by common stock. The following features are usually associated with preferred stock: Preference in dividends. Preference in assets in the event of liquidation. Convertible into common stock. Callable at the option of the corporation. Nonvoting. In general, preferred have preference to dividends payments. A preference does not assure the payment of dividends, but the company must pay the stated dividend rate prior to paying any dividends on common stock. Preferred stock can either be cumulative or noncumulative. A cumulative preferred requires that if a company fails to pay any dividend or any amount below the stated rate, it must make up for it at a later time. Dividends accumulate with each passed dividend period, which can be quarterly, semi-annually, or annually. When a dividend is not paid in time, it has "passed" and all passed dividends on a cumulative stock is a dividend in arrears. A stock that doesn't have this feature is known as a noncumulative or straight preferred stock and any dividends passed are lost forever if not declared.

Other features or rights

Preferred stock may or may not have a fixed liquidation value, or par value, associated with it. This represents the amount of capital that was contributed to the corporation when the shares were first issued. Preferred stock has a claim on liquidation proceeds of a stock corporation, equivalent to its par or liquidation value unless otherwise negotiated. This claim is senior to that of common stock, which has only a residual claim.

Almost all preferred shares have a negotiated fixed dividend amount. The dividend is usually specified as a percentage of the par value or as a fixed amount. For example Pacific Gas & Electric 6% Series A preferred. Sometimes, dividends on preferred shares may be negotiated as floating i.e. may change according to a benchmark interest rate index such as LIBOR. Some preferred shares have special voting rights to approve certain extraordinary events (such as the issuance of new shares or the approval of the acquisition of the company) or to elect directors, but most preferred shares provide no voting rights associated with them. Some preferred shares only gain voting rights when the preferred dividends are in arrears for a substantial time. The above list, although including several customary rights, is far from comprehensive. Preferred shares, like other legal arrangements, may specify nearly any right conceivable. Preferred shares in the U.S. normally carry a call provision, enabling the issuing corporation to repurchase the share at its (usually limited) discretion.

Types of preferred stock

In addition to the straight preferred, as just described, there is great diversity in the preferred stock market. Additional types of preferred stock include:

Prior Preferred StockMany companies have different issues of preferred stock outstanding at the same time and one of them is usually designated to be the one with the highest priority. If the company has only enough money to meet the dividend schedule on one of the preferred issues, it makes the dividend payments on the prior preferred. Therefore, prior preferred have less credit risk than the other preferred stocks but it usually offers a lower yield than the others. Preference Preferred StockRanked behind the company's prior preferred stock (on a seniority basis), are the company's preference preferred issues. These issues receive preference over all other classes of the company's preferred except for the prior preferred. If the company issues more than one issue of preference preferred, then the various issues are ranked by their relative seniority. One issue is designated first preference, the next senior issue is the second and so on. Convertible Preferred StockThese are preferred issues that the holders can exchange for a predetermined number of the company's common stock. This exchange can occur at any time the investor chooses regardless of the current market price of the common stock. It is a one-way deal so one cannot convert the common stock back to preferred stock. Cumulative preferred stockIf the dividend is not paid, it will accumulate for future payment. Exchangeable preferred stockThis type of preferred stock carries an embedded option to be exchanged for some other security upon certain conditions. Participating Preferred StockThese preferred issues offer the holders the opportunity to receive extra dividends if the company achieves some predetermined financial goals. The investors who purchased these stocks receive their regular dividend regardless of

how well or how poorly the company performs, assuming the company does well enough to make the annual dividend payments. If the company achieves predetermined sales, earnings or profitability goals, the investors receive an additional dividend. Perpetual preferred stockThis type of preferred stock has no fixed date on which invested capital will be returned to the shareholder, although there will always be redemption privileges held by the corporation. Most preferred stock is issued without a set redemption date. Putable preferred stockThese issues have a "put" privilege whereby the holder may, upon certain conditions, force the issuer to redeem shares. Monthly income preferred stockA combination of preferred stock and subordinated debt. Non-cumulative preferred stockDividend for this type of preferred stock will not accumulate if it is unpaid. Very common in Trumps and bank preferred stock, since under BIS rules, preferred stock must be non-cumulative if it is to be included in Tier 1 capital. Users Preferred shares are more common in private or pre-public companies, where it is more useful to distinguish between the control of and the economic interest in the company. Government regulations and the rules of stock exchanges may discourage or encourage the issuance of publicly traded preferred shares. In many countries banks are encouraged to issue preferred stock as a source of Tier 1 capital. On the other hand, the Tel Aviv Stock Exchange prohibits listed companies from having more than one class of capital stock. A single company may issue several classes of preferred stock. For example, a company may undergo several rounds of financing, with each round receiving separate rights and having a separate class of preferred stock; such a company might have "Series A Preferred," "Series B Preferred," "Series C Preferred" and common stock.