Common Stock: What It Is & How It Works
Common stock, referred to as shares, is a small piece of a company that represents a fraction of ownership. Holders of common stock usually have voting rights to elect the board of directors and vote for or against various corporate policies. Learn more about how they work and their risks.
What Are Common Stocks or Shares?
Common stock, or share, is a small piece of a company that represents fractional ownership and gives the holder a claim on the company's earnings as well as certain rights such as voting on the future of the company.
How Do Common Stocks Work?
Companies sell common stock to raise money, which they then use for various initiatives, like general corporate purposes, growth or new products. Investors who buy common stock own a small piece of the company and share in its profits. They usually have the right to vote on what happens at the company.
Common stock is an asset that may appreciate in value, hopefully giving you the opportunity to sell it in the future at a higher price than what you bought it for. However, share prices may also decline. Some common stocks pay dividends as well, although not all of them do. A dividend is a share of the company's earnings paid out to shareholders.
If a company files for bankruptcy, common shareholders are last in line to claim residual assets. Creditors and then bondholders have the first claims on the assets, followed by preferred shareholders, and then common shareholders.
Why Invest in Common Stock
The biggest reason to invest to invest in common stock is to earn a return on your investment when the price appreciates or when the company pays dividends. Among all asset classes, stocks can offer some of the highest long-term gains if an investor chooses successfully. When a stock appreciates, investors can elect to sell your shares for a profit, resulting in realized gains on the capital invested initially.
Other benefits include:
- Outperforms Bonds & Preferred Shares: They often outperforms bonds and preferred shares, although during some periods bonds often perform better—it depends on where the market is in the current cycle. When interest rates are low, both common stocks and bonds may do well because their yields are more attractive.
- Accessibility: It's fairly easy to buy common stock because it's available on multiple trading platforms and at many online brokerages. This makes it one of the most accessible asset classes because you don't need to be an accredited investor or high-net-worth individual with millions of dollars to invest.
Risks of Investing in Common Stock
The number one risk of investing in common stock is that the share price will decline, causing you to lose some or all of your investment. The main reason to invest is for the stock to appreciate, but that's never guaranteed to occur. Additionally, stock prices can sometimes be quite volatile. Thus, common stock is considered to be a high-risk asset class.
A large number of things can cause a company's common stock price to fall, including:
- Headline risk: the risk that earnings or other news is negative, driving investors to sell. Sometimes investor concerns don't prove to be valid, and the affected stock price rebounds. Both real and perceived, company-specific and industry-wide problems can affect companies' stock prices.
- Regulatory and legislative changes risk: regulatory changes can restrict their growth potential or require companies to alter the way they do business. Such developments can also weigh on common stock prices.
- Business model or products become obsolete
- Competitive threats put pressure on their sales and profits
Common Stock vs. Preferred Stock
Common stock and preferred stock share some characteristics, although they also are quite different. Both represent a piece of a company, but when people talk about stocks, they usually mean common stock unless they specify that they are speaking about preferreds.
| Common Stock | Preferred Stock | |
| Offered by All Public Companies | Yes | No |
| Right to Vote | Yes | No |
| Volatility | Higher | Lower |
| Dividends | Typically not offered | Typically offered & prioritized |
| Paid Out If Company Liquidates | Lower priority | High priority |
- Offered by all public companies: Not all public companies issue preferred stock while all do issue common stock when they go public.
- Voting rights: Common shareholders usually have the right to vote on what happens at a company, while preferred shareholders usually don't.
- Volatility: Common stock often outperforms preferred stock, which tends to be less volatile than common.
- Dividends: Preferred stock usually pays a dividend, while common stock often does not. Preferred shareholders also have priority over common shareholders when it comes to dividends and usually receive higher dividends.
- Company liquidation or files bankruptcy: Preferred shareholders rank before common shareholders if the company liquidates or goes bankrupt. Common shareholders only get paid if there is something left over after creditors, bondholders, and preferred shareholders are paid.
How to Buy Common Stock
The easiest way to buy common stock is through an online brokerage arm at your financial institution, or through other brokerages like Robinhood or eToro. Investors can also buy directly, in some cases, from the company. To buy through an online brokerage, you will need to set up an account and fill out an application.
When you're trying to learn how to find common stock, it makes sense to conduct due diligence before buying anything. Not all stocks are wise investments. Some key things to look at are:
- Earnings numbers and estimates
- Revenues
- Risk factors
- Anything else that could affect the company's stock price
Important information like this, as well as company SEC filings, are available at Seeking Alpha.
Some companies will allow you to buy stock directly from them, and you can usually find out more by visiting the investor relations page of its website. Here you can find information about direct stock purchases or dividend reinvestment plans. It is sometimes possible to place an order for stock on the company's website.
Tip: The easiest way to buy common stock is through an online brokerage, although in some cases you can also buy stock directly from companies via their investor relations websites.
Should You Invest In Common Stocks?
One of the biggest factors to consider when deciding whether to invest in common stocks is your level of risk tolerance. Since stocks can be among the riskiest asset classes to invest in, investors should have a certain level of risk tolerance.
Common stocks can be very volatile, so you might lose money on your investment, even if only in the short term. Investing in common stocks can be an emotional rollercoaster at times.
It's never a good idea to invest money that you can't afford to lose. Also, it's often a good idea to commit to a long investment holding period to ride out short-term volatility. Diversifying and owning multiple stocks is also a good idea because ideally, some stocks may appreciate while other stocks decline in price at the same time. Exchange Traded Funds (ETFs) usually provide substantial diversification, and may be a good alternative for some investors.
If you're looking for significant long-term gains, it might make sense to invest in common stocks, as long as you choose wisely. However, it usually isn't a good idea to invest directly in common stock if you don't have enough money to also invest in other assets. Sometimes all stocks decline due to market factors, so diversification across asset classes can help protect wealth.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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