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Common Stock

Common Stock is the ownership interest in a corporation. Shareholders bear all the risks and rewards of ownership. It enables investors to independently and voluntarily participate in the economic activities of a business. From a text book standpoint, shareholders are passive investors and have limited liability; they can only lose their investment, and are not responsible for the liabilities of the business. Shareholders are also last in line to claim the assets and income of a company.  

Some of the main benefits of owning stock are:

  • It provides a natural hedge against inflation; for young investors, it’s an excellent savings vehicle.
  • Over a long period of time (a decade or two), the return on common stocks is usually better than fixed income securities.
  • It’s the primary method of ownership and control of a corporation.
  • Excess profits are returned to the shareholders through dividends, share repurchases or reinvestment in the business.

The drawbacks to common stocks are that the risks are high, and stock prices can be volatile.

Common stock, evidenced by a stock certificate, entitles the owner to a prorated financial interest in a company. Shareholders also have the right to vote for the Board of Directors. While one share usually equates to one vote, different classes of stock, with different ownership rights and votes, are allowed.

Shareholders are entitled to the following:

  • Last claim on a company’s assets in the event of liquidation. In most cases, don’t expect anything in a wind-down situation; the attorneys, accountants and bankers get paid first.
  • Preemptive rights may be attached to the shares, which grant the shareholder the right to purchase additional shares to keep proportional ownership in the company.
  • Inspection of the books and records of a company.
  • Ability to sue management for unauthorized transactions.

Dividends are not a right, but a privilege. Some companies, however, make it a practice to pay out a certain percentage of their cash flow as dividends. Tying dividend payments to cash flow forces cash flow management on a company; as the business grows the cash flow dividend to shareholders automatically increases.

Common stock held by the company is referred to as treasury stock. Par value is the original value assigned to the company, and paid for by the original investors.

While the returns generated from common stock may be high compared to other asset classes, there is also a great deal of risk involved in ownership. For instance, consider the computer industry. Google, Yahoo and eBay are all relatively new start-up companies, that are taking the leadership positions away from Microsoft, Intel and Cisco. Two decades ago, the leaders were IBM, Burroughs, NCR, Sperry, Digital and Wang.  As leadership and profits change, so does the value of the shares. Business is fast moving; while returns are high, investors need to focus on the “risk- reward” equation.

Added Perks: Owning shares of a company may have an added perk. Many companies offer shareholders discounts to their products. J.P. Morgan, for example, used to offer to their shareholders discounted tickets to the Christmas Show at Radio City Music Hall. Call the investor relations departments of the companies you own stock in, to find out about the perks they offer their shareholders. You may be surprised!

Do Your Home Work!

Finding and investing profitably in common stocks is difficult and requires hard work and some luck. While the internet has made researching investments easy, it’s still time consuming. Start with Yahoo, whose screens have an excellent overview of many companies, and contain stock price histories, detailed current information, and trends. Most importantly it provides access to a company’s SEC Edgar filings. These legal filings explain a company’s business model and financials. It’s a “must read” for every company you own or want to invest in. Listen to management’s live quarterly meetings, which can be accessed from a company’s website. Normally, their presentations are also on the web. The Q&A portion of conference calls is very interesting. These presentations normally take 1 to 2 hours. It’s a very good way to get to know a company and its management. The Value Line Investment Survey, found in most public libraries, is also an excellent research tool. It lists all the major companies by industry. It’s easy to compare your selection to its competitors. Value Line has a good summary of all the key figures and ratios of a company.  Zacks.com is another source I use. They have very good EPS projections on many companies. Reuters has an excellent selection of daily e-mail newsletters that are delivered to your desktop. The Wall Street Journal and the business section of The New York Times are the gold standards for sources of business ideas. Investing is a job that cannot be delegated! Of course, don’t forget to read my two books "The Chestnut and Cedar Stock Report - Investment Handbook for Young Adults" and “Stocks 4.0" they are filled with information on how to research a company and pick a stock!

Investing in common stock is one of the best ways of building wealth.

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