Common Stock and Preferred Stock
Direct Equity Investment
Common Stock and Preferred Stock are two major direct equity investments. When investing directly, investors can choose money market securities, capital market securities or the securities in the derivatives market that include options and financial futures contracts. However, the followings are major direct equity investments:
Common stock may be defined as the residual ownership of a corporation, which is entitled to all assets and earnings after the other limited claims have been paid and which has the basic voting control. In short, common stock is the fundamental ownership equity. The investor in common stock thus occupies a position directly comparable to that of the owner of a firm or a factory. Common stock bears the main burden of the risk of the enterprise and also receives the lion’s share of the advantages of success. Common stock has no maturity date rather its life is limited by the length of time stated in the corporate charter.
Common stock represents the ownership interest of corporations. Among other things, the holders of common stock elect the board of directors, have a right to the earnings of the firm after all expenses and obligations have been paid, also run the risk of receiving nothing if earnings are insufficient to cover all obligations. Holders of common stock receive a return in the form of the distribution of corporate income like dividends and capital appreciation. Common stockholders have only a residual claim against the income and assets of the firm. Thus, the potential for gain is greater for holders of common stock than that for debt-holders whose gain is fixed. In contrary, the risk for the equity owners is correspondingly greater since they have last claim to the firm’s income and assets.
However, the characteristics of common stock can be summarized as the following manner –
- It normally has control of the corporation and will exercise that control in its own interest.
- It has unlimited ownership rights to the remaining gains from the business after other security-holders have received their contractual payments.
- It bears the principal hazards of the business.
- Common stock maybe sold by its holder to any willing buyer.
- The earnings on the common stockholder’s equity may be unstable.
- Dividends may fluctuate. It must depend on earnings, cash position, surplus position, expansion needs, debt situation and management policy.
- Common stock prices fluctuate extensively.
- Common stocks in general are a price-level hedge. That is, they tend to earn, pay dividends and bring market prices at levels which are vaguely related to the general commodity price level.
- Dividends are normally less than the earnings on the common stockholders’ equity.
- Common stockholders have voting power to vote for the board of directors and for against major issues of the corporation.
- Common stockholders have preemptive right to subscribe to any new issue of stock so that they can maintain their previous fraction of the total number of shares sold.
- Par value common stock just like preferred stock can be par or no par.
The market value of common stock is the variable of concern to investors. The aggregate market value of a corporation which is calculated by multiplying the market price per share of the stock by the number of shares outstanding determines the total value of the firm as estimated in the market place. Dividends are the cash payments which are distributed to the common shareholders by the corporation.Common Stock and Preferred Stock.
However, the followings are the types of dividend concerned:
◘ Dividend yield: It is the amount of dividend per share divided by market price of the same. This income component of a stock’s return is stated on a percentage basis.
◘ Dividend payout ratio (D/P ratio): It refers to the ratio of dividends to earnings. It indicates the percentage of a firm’s earnings paid out in cash to its shareholders.
◘ Retention ratio: It is the complement of payout ratio indicating the percentage of firm’s current earnings retained by it for reinvestment purposes.
– Common Stock and Preferred Stock –
Preferred stock is a hybrid sorts between a fixed and variable income security. It is an equity security with an intermediate claim between bondholders and stockholders on a firm’s assets and earnings. In the event of liquidation, preferred stockholders have a claim on available assets before the common stockholders. In addition preferred stockholders get their stated dividends before common stockholders receive any dividends. Many issues of preferred stock are callable at a stated redemption price. Preferred stocks are usually perpetual securities having no maturity date, although there are exceptions to the general rule.
However, following are the special features of preferred stock –
- Some preferred stockholders have voting rights and some preferred stockholders do not have this right and voice in the management.
- Preferred stockholders have preemptive right to subscribe to additional issues of common stock but non-voting preferred stock have no preemptive right.
- Most preferred stock have par value. In this case, the shares’ cash dividend rights are usually stated at a percentage of par value.
- Cash dividends are the most significant aspect of preferred stock in which the stockholders should get more gain from dividends than from capital appreciation.