Stock Issues: Common Stock
The ownership of a corporation is divided into transferable units known as shares of stock. There are several categories, or classes, of stock. Individuals and companies buy stocks because they expect to profit when the corporation makes profits. Corporations issue two basic types of stock: common stock and preferred stock.
Corporations differ from other types of business structures, such as sole proprietorships and partnerships. In sole proprietorships, one person (the owner) receives the profits. In partnerships, only the partners share in any financial gains. But in a corporation, hundreds, thousands, and sometimes even millions, of stockholders share the profits. Furthermore, in the corporate structure, stockholders may buy and sell ownership (company stock) without interfering with the activities of the corporation. There are millions of transactions that occur daily on stock exchanges, and they are independent transactions between buyers and sellers that do not affect the daily operations of the corporations involved. This is in contrast to sole proprietorships and partnerships, where the life of the business ceases when ownership changes.
Sole Proprietorship Partnership Corporation
One other important distinction between a corporation ant the other types of business structures is investors (stockholders) in a corporation limit their losses to the amount that they invest in shares of stock, if the company would get in to serious financial difficulties.
The most popular investment vehicle in the stock market is common stock. One share of common stock represents one-part ownership in a corporation. If you owned 1,000 common shares of ABC Corporation, and they have 100,000 shares outstanding (sold), then you would own 1% of the ABC Corporation. As a shareholder (owner), you have the right to vote on important corporate issues, such as the election of a corporation’s board of directors, and mergers or acquisitions (the joining with, or the taking over of, another company).
There are two basic ways that an investor can make money by buying common stock. The first way is that the stock could increase in market value. The stock price will increase in market value when buyers bid the stock price up when trying to acquire shares of the stock. You, no doubt, have seen this happen with other consumer products. When the PlayStation 2™ Video Game System first came out, everybody wanted one, but there were not enough systems available; thus, people were willing to pay more than the suggested retail price in order to acquire the system. While game players were trying to acquire the system, investors were trying to acquire Sony (the manufacturer) stock. Those investors who currently held Sony stock could sell to those trying to acquire the stock at a price higher than the price they originally paid for the stock, thus making a profit.
The second way of making money via common stock is through the corporation’s dividend policy. A dividend is money given to each shareholder as a way of sharing the corporate profits with the owners or stockholders. Typically, the more profit a corporation makes, the more dividends the stockholders make.
It should be noted at this point that making money by investing in common stock is not guaranteed. The market price of the stock could drop in value if the company is mismanaged or if the company does not live up to investors’ expectations. Furthermore, dividends are not guaranteed either. Looking at a company’s past dividend record gives you a pretty good idea of how much in the way of dividends per share they are likely to pay in the future, but the corporation is under no legal obligation to pay dividends.
A distinctive feature of corporations is that they have shares of stock, and they can distribute profits to the shareholders via dividends. The dividends that are paid to shareholders represent a positive return on investment (profit) for the firm and can be directly distributed to the shareholders. As mentioned above, the payment of dividends is at the discretion (option) of the board of directors. Some important characteristics of dividends include the following:
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