What are Common Stocks?

Key Highlights

• The common stock is a security representing the company's ownership.

• After paying the creditors, bondholders, and preferred shareholders, - common stock owners get whatever remains of their assets during liquidation.

• The stockholder's equity section of the corporate balance sheet shows the value of a common share of stock issued.

Understanding Common Stocks Meaning

A common stock is an asset that reflects the shareholders' interest in a company. You are entitled to vote on the board of directors and hold voting rights once you own shares in a company. These voting rights give you the possibility to participate in company decisions as well as vote on a number of corporate policies.

Through higher yields, common shares give investors a better return in the long run. However, only after the company has repaid the preferred shareholders, bondholders, and other creditors in full will the common shareholders have the right to the company's assets if the company decides to liquidate. The common shares are listed in the equity portion of the company's balance sheet.

Why are Common Stocks Issued?

As an alternative to the sale of debt bonds or preference shares, common stock is usually issued. Raising capital is the most important reason for issuing common shares. A number of uses can be made of the capital received, such as.

1. Expansion

If businesses expand further, they can raise their goodwill and profits. This enables companies to increase their market shares by raising capital in the form of share issues and using that money to achieve their expansion objectives.

2. Acquisition

The acquisition of a competitor or a promising company in the same sector is one of the best ways for a company to expand. Companies issue common shares for the purpose of financing acquisitions, which may be very expensive.

3. Paying off debts

In order to finance the early stages of the company's business cycle, almost every company borrows money. They must use their revenues to settle the debt as soon as they stabilise their business activities. However, if companies would like to repay those loans in one go, they can issue shares.

4. Establishment of a cash reserve to be used at the appropriate time.

Companies also make a cash reserve for the occurrence of an emergency event, like individuals who save for emergencies. Since it is prohibited to use profits for this purpose, companies are encouraged to issue shares and draw up capital reserves that can be used in the future.

The holding capacity of existing shareholders is likely to be reduced by the issuance of more common shares on the market. Therefore, before the final decision is taken, it is common for business owners to be cautious and take into account both the advantages and disadvantages of issuing shares.

Features of Common Shares

The common stock has a variety of features that make it attractive to investors, such as follows.

1. Ownership

The ownership of investors in a company is reflected in the common shares. For example, if you own 1,000 shares in a company, the corporation is owned at the same percentage of its value.

2. Powers

The common stock enables investors to have a variety of powers, such as the election of the board of directors and the vote on internal policy matters.

3. Exchange

Just like other types of shares, common shares are listed on the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE).

4. Repayment

At the time of liquidation of the company, the common shares and the common shareholders are not paid, but the preferred shareholders, bondholders, and other creditors.

5. Transaction

Common shares are also traded and sold at the same level as other stocks. For the purpose of purchasing and selling shares, investors shall have a demat account and a trading account.

Benefits of Common Stocks

The benefits of a share are as follows.

1. Better return

The maximum amount that a shareholder can earn is not determined for ordinary shares. As long as investors so choose, they can store their shares for a certain period and benefit from constant profits. In addition, common shares are cheaper and more risky than any of the debt instruments.

2. Limited liability

A common share allows investors to achieve stable returns while avoiding any other legal obligations. In the event of a company making good earnings, shareholders may receive dividends but are not subject to liability if the company incurs losses or decides to wind up.

3. Voting rights

The right to vote is popular with investors because it allows them to participate in the company's decision-making process. The voting rights ensure that their investment is protected and continues to move in a positive direction since the profits are directly related to company policies.

Limitations of Common Stock

The drawbacks of common stocks are as follows.

1. There is no guarantee of profits

The income is often variable as market forces tend to have a large effect on revenue generation from this stock option. When it comes to making a profit, there is no such certainty. For individuals who have invested in common stocks for their growth potential, this is a significant drawback.

2. Market-linked risk

Since the prices of individual shares are subject to market volatility, fluctuations in stock prices occur on a regular basis. In addition, due to the rapid change in the valuation of shares, it is becoming quite difficult to carry out performance evaluations. Moreover, common shareholders are more vulnerable to losing their entire investment in the case of bankruptcy.

3. Lacks control

It is mainly the business strategies and associated policies that determine the extent to which investors can profit from their investment in common shares, which means that they have no control over them. Furthermore, the authority of investors is restricted by the fact that they are not allowed to vote on policies or review the company's business plans or accounting records.

Conclusion

For investors who want a long-term investment, common stock holdings can provide an efficient way of realising good returns on investments. You can open a free Demat and trading account at Kotak Securities if you wish to invest in common shares. Go to the Kotak Securities website or download the Kotak Securities Market application from the App Store.