Common stock

Definition

Common stock is a type of security that represents ownership in a corporation, granting shareholders voting rights and the potential to receive dividends. It’s crucial for understanding a company's capital structure, as common stock holders are last in line for claims on assets in the event of liquidation but have the opportunity for capital appreciation. This ownership stake connects directly to shareholders' equity, balance sheet components, and strategies for enhancing shareholder value.

5 Must Know Facts For Your Next Test

1. Common stockholders usually have voting rights that allow them to influence corporate governance, such as electing the board of directors.
2. In times of liquidation, common stockholders are paid after all debts and preferred stockholders have been satisfied, making it a riskier investment.
3. Companies often issue common stock to raise capital for expansion or operations, which can dilute existing shareholders' ownership percentages.
4. The price of common stock can fluctuate based on market conditions, company performance, and investor sentiment, leading to potential capital gains.
5. Dividends paid on common stock are not guaranteed and can vary based on a company's profitability and strategic decisions regarding profit allocation.

Review Questions

• How does the issuance of common stock impact a company's balance sheet and overall financial health?
  • When a company issues common stock, it increases the shareholders' equity section of its balance sheet by adding cash or other assets received in exchange for shares. This infusion of capital can improve financial health by providing funds for growth opportunities or operational needs. However, it may also dilute existing ownership percentages, impacting control among current shareholders. Thus, while issuing common stock can strengthen a company's finances, it must be carefully balanced with the interests of existing investors.
• Discuss the advantages and disadvantages of investing in common stock compared to preferred stock.
  • Investing in common stock offers advantages like voting rights and potential for higher returns through capital appreciation and dividends that can increase over time. However, common stockholders face disadvantages such as higher risk during liquidation since they are paid after debt holders and preferred shareholders. Preferred stock provides more stability through fixed dividends and priority in asset distribution but typically lacks voting rights. Therefore, an investor's choice depends on their risk tolerance and investment goals.
• Evaluate how effective shareholder value creation strategies can enhance the attractiveness of common stock for investors.
  • Effective shareholder value creation strategies—such as increasing profitability, implementing share buybacks, or consistently paying dividends—can significantly enhance the attractiveness of common stock. By focusing on these strategies, a company can boost its market capitalization, driving up stock prices and yielding greater returns for investors. Additionally, aligning management incentives with shareholder interests through performance-based compensation encourages decisions that benefit common shareholders, thus fostering long-term loyalty and investment in the company.

Related terms

dividends: Payments made by a corporation to its shareholders, typically from profits, providing a return on investment.

preferred stock: A type of stock that provides dividends at fixed rates and has priority over common stock in asset distribution during liquidation.

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