TABLE OF CONTENT
- What is Common Stock?
- What is the Purpose of Issuing Common Stocks?
- Advantages and Disadvantages of Common Stock
Common Stocks: Meaning, Advantages, Disadvantages & Purpose
What is Common Stock?
Common stock is the type of security that describes the investor’s ownership of a company. Such a stock option offers investors the power to choose the company’s board of directors and further extends them into voting rights to plan corporate policies.
Common stocks, abbreviated as common shares, can generate returns at a high rate. The common shareholders possess all the rights to claim the company’s assets in the event of the company’s liquidation after they have paid to shareholders, bondholders, and other debt holders in full.
An individual can issue common stocks from the company’s initial public offering (IPO). The balance sheet of a company consists of a stockholder equity section where all common stocks are reported.
To know the number of stocks a particular company offers, one can subtract the total treasury stocks from the total number of shares issued.
What is the Purpose of Issuing Common Stocks?
The primary goal of issuing common stocks is to raise capital. The capital raised by a particular company is used for several purposes like:
- Business expansion
- Paying off outstanding debts
- Creating a future cash reserve
- Acquisition of a promising company
One of the major aspects of issuing common stocks is that the market dilutes the power of old and existing shareholders.
The company has a specific goal either to avoid the dilution or to aim for it. Hence these motivations lead the company to issue more common stock.
Advantages and Disadvantages of Common Stock
The issuing of common stock has several benefits that are summarized below:
- Performance
- Voting rights
- Liquidity
- Limited Legal Liabilities
Common stocks, when compared to bonds and deposit certificates, perform better. However, there is no upper limit on the investor's earnings from their common stock holdings. Therefore, common stocks are less expensive and more practical alternatives against debt investment.
One voting right is vested to an investor per share of each common stock held. These voting rights help investors to take part in business decisions and the creation of corporate policies.
In some cases, investors have the right to elect the board of directors by exercising their voting rights. The more common stocks investor has the more power they will swing the policies in a company.
Due to their liquidity features, common stocks can be easily surrendered or invested by investors. Thus, these stocks help investors buy shares and walk away with all their funds if the company does not give results to their expectations.
Liquidity offers the investors flexibility to do with their investments what they see fit without any hassle.
Beyond the financial investment events that occur within the company, the obligations of common shareholders still exist, and they need to be concerned with all legal liabilities.
When the company is giving growing returns across time, common shareholders know passive recipients of a fixed income of sorts.
Passive shareholders are not responsible in case the company liquidates or gets into legal trouble.
Disadvantages
- Market Risks
- Uncertainty
The major risk associated with the common share is the market risk. Market risk is the issue of the company underperforming over a period.
A substantial decline in the company's performance can lead to the profit being eaten by the shareholders and not getting the dividends they are looking for.
This is an essential parameter to consider because common shareholders are not the only and the first ones to receive payout benefits even when the company is performing extremely well.
Even though common shareholding can be considered a fixed-income option, there is no guarantee of payouts. However, the major difference here is that the income is not guaranteed when one expects it based on the fund's availability in the company and how they are allocating those funds.
When the company starts to allocate dividend payouts, investors and common stockholders are not the only ones to receive immediate payouts.
They receive their dividends after shareholders and bondholders are entitled to receive full dividends. Hence there is a degree of uncertainty and lack of control when it comes to the profitability of common stocks.
FAQS
- What is the primary goal of issuing common stocks?
- Which is more associated while issuing common shares in the market?
- What is Common Stock?
- Can stocks be easily surrendered or invested by investors?
The primary goal of issuing common stocks is to raise capital. The capital raised by a particular company is used for several purposes like:
1) Business expansion
2) Paying off outstanding debts
3) Creating a future cash reserve
4) Acquisition of a promising company
The major risk associated with the common share is the market risk. Market risk is the issue of the company underperforming over a period.
Common stock is the type of security that describes the investor’s ownership of a company. Such a stock option offers investors the power to choose the company’s board of directors and further extends them into voting rights to plan corporate policies.
Yes, due to their liquidity features, common stocks can be easily surrendered or invested by investors. Thus, these stocks help investors buy shares and walk away with all their funds if the company does not give results to their expectations.
Final Thoughts
Offering common shares is an effective way of sharing ownership in a company. Investors with common stocks own voting rights without any stress of company legalities.
However, the profitability of most common stocks is limited because they are prioritized in payouts and the company's freedom to defer dividends until funds are largely available.
