Common stock

Definition

Common stock represents ownership in a corporation and typically comes with voting rights and the potential for dividends. Investors who hold common stock have a claim on the company's assets and earnings, but they are last in line to be paid in the event of liquidation, which makes it riskier than other types of equity. It plays a vital role in corporate finance as it reflects a company's financial health and market valuation.

5 Must Know Facts For Your Next Test

1. Common stockholders usually have voting rights, allowing them to participate in major corporate decisions, such as electing the board of directors.
2. Dividends on common stock are not guaranteed; companies may choose to reinvest profits instead of paying them out.
3. In case of bankruptcy or liquidation, common stockholders are paid after all debts and preferred stock obligations have been settled.
4. The price of common stock can be influenced by market conditions, company performance, and investor sentiment, which can lead to significant price volatility.
5. Common stock can be issued as a way for companies to raise capital for expansion, research, or other operational needs.

Review Questions

• How does owning common stock impact an investor's influence on corporate governance?
  • Owning common stock grants investors voting rights, allowing them to influence corporate governance by participating in decisions such as electing the board of directors or approving major changes. This means that shareholders can have a direct say in how the company is run and its strategic direction. However, the actual impact may vary depending on the number of shares owned and the overall ownership structure.
• Discuss the differences between common stock and preferred stock in terms of risk and return for investors.
  • Common stock generally carries more risk than preferred stock because it does not guarantee dividends and has lower priority during liquidation. While preferred stockholders receive fixed dividends before any distributions are made to common stockholders, common stockholders may benefit from higher returns through capital appreciation if the company performs well. Therefore, investors must weigh their risk tolerance against their return expectations when choosing between these two types of equity.
• Evaluate the significance of market capitalization when analyzing a company's financial health and its implications for common stockholders.
  • Market capitalization is crucial for assessing a company's size and overall market value, which can provide insights into its financial health. A higher market cap often suggests a more stable company with less risk for common stockholders, while a lower cap may indicate potential volatility. Additionally, market capitalization can affect investor perception; larger companies are often viewed as safer investments compared to smaller firms. Understanding this relationship helps common stockholders make informed decisions regarding their investment strategies.

Related terms

preferred stock: Preferred stock is a type of equity security that typically provides dividends at fixed rates and has priority over common stock in asset distribution during liquidation.

market capitalization: Market capitalization is the total market value of a company's outstanding shares of common stock, calculated by multiplying the current share price by the total number of shares.

earnings per share (EPS): Earnings per share is a financial metric that indicates how much profit is attributed to each outstanding share of common stock, used to assess profitability.