Common stock is a security that represents ownership in a corporation. Holders of common stock exercise control by electing a board of directors and voting on corporate policy. Common stockholders are on the bottom of the priority ladder for ownership structure; in the event of liquidation, common shareholders have rights to a company’s assets only after bondholders, preferred shareholders and other debt-holders are paid in full.
If a company goes bankrupt, the common stockholders do not receive their money until the creditors and preferred shareholders have received their respective share of the leftover assets. This makes common stock riskier than debt or preferred shares. The upside to common shares is they usually outperform bonds and preferred shares in the long run. Many companies issue all three types of securities. For example, Wells Fargo & Company has several bonds available on the secondary market. It also has preferred stock, such as its Series L (NYSE: WFC-L) and common stock (NYSE: WFC).
The first ever common stock was established in 1602 by the Dutch East India Company and introduced on the Amsterdam Stock Exchange. In 2016, there are over 4,000 stocks traded on major exchanges and over 15,000 traded over the counter. Larger U.S.-based stocks are traded on a public exchange such as the New York Stock Exchange or NASDAQ. There are also several international exchanges for foreign stocks, such as the London Stock Exchange or the Japan Stock Exchange. Companies that are smaller in size and unable to meet an exchange’s listing requirements are considered unlisted. These unlisted stocks are traded on the Over-The-Counter Bulletin Board (OTCBB) or pink sheets.
For a company to issue stock, it must begin by having an initial public offering. An IPO is a great way for a company seeking additional capital to expand. To begin the IPO process, a company must work with an underwriting investment banking firm, which helps determine both the type and pricing of the stock. After the IPO phase is completed, the general public is allowed to purchase the new stock on the secondary market.
Why Invest in Stocks?
Stocks should be considered an important part of any investor’s portfolio. They bear a greater amount of risk when compared to CDs, preferred stock and bonds. However, with the greater risk comes the greater potential for reward. Over the long term, stocks tend to outperform other investments but are more exposed to volatility over the short term.
There are also several types of stocks. Growth stocks are companies that tend to increase in value due to growing earnings. Value stocks are companies lower in price in relation to their fundamentals. Value stocks offer a dividend unlike growth stocks. Stocks are categorized by market capitalization in either large, mid or small. Large-cap stocks are much more traded and are an indication of a more stable company. Small-cap stocks are newer companies looking to grow, so they are much more volatile compared to large caps.