Common Stock Explained: How Common Stock Works
Written by MasterClass
Last updated: Mar 29, 2022 • 2 min read
When most people buy stock on the stock market, they purchase shares known as common stock.
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What Is Common Stock?
A common stock is a basic stock that offers proportional equity in a business and voting rights on company issues. Different classes of common stock in a public company allot different voting rights based on the class of stock the common stockholders own. Also called an ordinary share or voting share, common stocks are the most typical kind of stock that average investors can purchase.
How Common Stock Works
Traditionally, holders of common stock purchase their shares on a public exchange such as the New York Stock Exchange (NYSE) or the NASDAQ. The initial shares may be offered via an initial public offering (IPO), and traditionally more shares are added (usually via stock splits) over the life of the company.
A share of common stock grants a person equity ownership in the company. While this does not give a common shareholder control over the issuing company, it does allow them to vote on some company business. Common shareholders typically vote for members of a company's board, and occasionally they are allowed to weigh in on broad corporate policy questions. A common shareholder's voting power is proportional to the amount of shares they own.
Common Stock vs. Preferred Stock: What’s the Difference?
Common stock and preferred stock (also known as preferred shares and common shares) are the two main types of stock sold in public exchanges. When you purchase shares of common stock or preferred stock, you effectively own a small portion of the company’s assets, which you can trade or sell at a later date. That said, there are a few key differences between the two:
- 1. Growth potential: Common stocks are subject to volatility and can experience significant fluctuations as the market price rises, which means they have almost unlimited potential for higher dividends. Preferred stocks usually come with a fixed-amount redemption value, meaning that stockholders won’t be able to sell their preferred stock for more than a set amount—even if the price spikes.
- 2. Stability: Since common stocks can experience significant value fluctuations, they run a higher risk of dropping to zero. Preferred stocks are a slower and more stable investment since they experience less dramatic swings and usually pay out a fixed dividend.
- 3. Voting rights: Common stockholders can vote on parts of a company’s operations, including its board of directors, internal policies, and significant financial decisions. Conversely, preferred stockholders usually do not have voting rights, and their opinions do not factor into decisions surrounding company operations.
- 4. Security of investment: In the event of liquidation, a company's bondholders are paid out before any stockholders. But when it comes to stock, preferred shareholders are paid before common stockholders. This means that preferred stockholders' equity is somewhat more secure than that of common stockholders.
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