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Equity Instruments
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Common Stock
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Preferred Stock
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Tracking Stock
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Spin-off
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Partial Spin-off
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Stock Rights
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Stock Classes
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Real Estate Investment Trust
(REIT)
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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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