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What Is Common Stock?

A Common Stock is a share in a company that entitles the stockholder to dividends that vary based on how the company is doing. You may even miss out on dividends if that company is doing poorly. Most companies only issue Common Stocks as opposed to Preferred Stocks. 

Even though Common Stocks are not guaranteed a dividend, they can be very valuable in the long term. Is a Common Stock an asset? Yes, it gives investors a small piece of ownership in a company. This can be extremely valuable (especially if you own a large quantity). Common stocks have the ability to raise its value significantly over time, and therefore are an attractive investment vehicle.  

Basics Of Common Stock

Before we really dive into what a Common Stock is, we need to review what the Stock definition is. From there we can understand how a Common Stock works. Are there any benefits associated? What are the tax implications? Are there any alternatives? Finally how does it compare to Preferred Stock? 

What Is A Stock?

Before we jump further into what a Common Stock is, we must understand what a Stock is in general. Stocks are a type of security that provides the stockholders with a share of ownership for a company. Stocks can also be known as “Equities”, these terms are synonymous and you may see them used interchangeably. 

People buy stocks in order to hopefully make money, either in the short term or long term. Or they wish to have an ability to vote, based on shares, to influence a company. This can be done via Capital Appreciation (which happens when the price of the stock rises). Or this can be done via Dividend Payments (when companies distribute earnings to shareholders). 

Companies issue stock in order to get money for different things. Some common reasons that companies need money are to launch new products. Or perhaps they want to expand into new regions or new markets, pay off debts, or to build new facilities/update existing ones. 

How Common Stock Works 

Common Stocks are bought and sold on stock exchanges throughout the day. The price of the stocks go up and down based on the demand of the stock. Pricing is determined by corporate earnings, any public relations announcements, as well as the overall health of the US economy.

Expected earnings for stocks fuels the demand. When investors expect earnings to rise, based on a recent product announcement for example, then they will bid up the price of the stock. If the current price is relatively low in comparison to the earnings, per the price to earnings ratio, this could definitely ramp up the stock price.

New companies are typically held privately. In issuing an IPO and going public, the companies can generate capital in order to expand. If there is an expected revenue growth, or a new company has a lot of potential, this can impact price tremendously.

Benefits of Common Stock

Some benefits of Common stocks are as follows:

  • Allows their shareholders to vote on corporate issues, ex: accepting takeover bids, or board of directors, etc.
  • Stockholders of Common Stocks receive a copy of the corporation’s annual report, which isn’t public knowledge
  • In most cases, stockholders also receive one vote per share. Ultimately, the more shares you have, the more weighted your voice is

Alternatives To Common Stocks

The most common alternatives to buying individual common stocks include Mutual Funds, ETFs, or Bonds. 

  • Mutual Funds: Mutual Funds are investment vehicles that pool money together from many different investors, and buy different types of securities. The combination of these securities in a Mutual Fund is known as a portfolio 
  • ETFs: ETFs are a collection of securities similar to a Mutual Fund, however, an ETF can be exchanged during the day like a stock
  • Bonds: Bonds are units of corporate debt securities that are issued by companies that can be traded. It is referred to as a fixed income security since bonds traditionally pay a fixed interest rate to debtholders 

What Are The Tax Implications?

Are there any tax impacts if I turn a profit on my investments? The answer is, yes, always. The government has to be funded somehow. When stocks are sold for an amount greater than their purchase price, this is called a profit. 

This amount you have gained is subject to capital gains tax, and it is taxed on whether it is considered short term or long term gains. How do I know if my profit is a short term or a long term gain though? It is a rather simple distinction. If the asset is held for a year or longer prior to it being sold, then the profit is considered a long term gain. If it was held less than a year, the assets profit is considered a short term gain. 

Short term capital gains are taxed at the rate of your income. So if you make $100,000, for simplicity’s sake, and you have a short term capital gain of $8,000. Your income for that year would be $108,000. Long term capital gains are a little bit different. They are taxed at a fixed rate depending on your filing status and amount earned. It could be anywhere from 0% up to 20%. 

Common Stock vs. Preferred Stock: An Overview

There are two types of stocks mainly, common and preferred stocks. Common stock owners are entitled to vote at shareholder meetings and also are eligible to receive dividends. They are paid out by companies based on how profitable they are, although not at a fixed rate. 

While you have voting rights, you are least likely to receive assets if the company goes under. With preferred stock options, you get priority over common stock options in the event that a company goes under. This is in addition to the fixed dividend payments. With that being said, there are a lot more common stocks selling on exchanges than there are preferred stocks. 

Consider Guidance From A Financial Advisor

A Common Stock is a useful tool in your toolbox when striving for gains on the stock market. They can give you a voice in a company and let you be part of the decision making process. In addition, to providing you insight into a company’s financial status. 

This should not be the only path you take when trying to make extra money, or trying to save for retirement. If you have more detailed questions or would like to speak to someone who has an extensive financial background, perhaps you should talk to a financial advisor