Common stock represents basic ownership of a corporation, whether a small privately owned company with a few shares held by a single owner and perhaps a few associates, or a giant publicly traded corporation with hundreds of thousands of stockholders. Common stock is by far the largest class of securities held and traded by general investors; when someone speaks of "owning stocks," usually common stock is implicit.
The holders of common stock rank behind all creditors (bondholders, banks, and other lenders) as well as any holders of preferred stock in their claims on the current income of the company, including any dividend distributions, and, in case of liquidation, on whatever assets remain. In essence, these senior holders must be paid their due before the common stockholders are entitled to anything. By the same token, once these senior claims are met, the entire income and increase in the value of the company accrues for the benefit of the common stockholders.
Common stock is divided into shares, each representing a proportionate part of the total common stock ownership. The corporate charter or bylaws fixes the number of shares that are authorized for issue. The issued shares are those that have actually been sold to stockholders or otherwise distributed in return for value—for acquisitions, options or grants to employees, stock dividends to stockholders, etc. Outstanding shares are those currently in the hands of stockholders. The difference between the number of issued and outstanding shares is usually accounted for by treasury stock—shares reacquired by the company through market purchases or special solicitations and held in the company's treasury. This stock is then available for reissue in employee stock plans, acquisitions, conversion of convertible bonds or preferred stocks, or other corporate operations. While in the treasury, such stock is not entitled to dividends, has no voting rights, and is not counted in the computation of earnings per share. For practical purposes, when looking at a company's capitalization, what counts is the number of outstanding shares.
Sometimes the common stock is divided into separate classes. Usually one class has greater (or even exclusive) voting power, often with the aim of keeping control within a founding family or the management circle. This practice increases the management's autonomy, but critics claim that it also diminishes the fiscal restraint that comes with being fully accountable to external shareholders. Some companies may grant their nonvoting common stockholders the right to receive larger dividends. Since the 1980s, the issue of dualor multi-class common stock has also been used as a preemptive measure against hostile takeovers.
Stocks have a par value (or, if the company chooses to issue no-par stock, a stated value). In modern times, this is strictly an accounting formality (accountants need a dollar amount at which each share is entered on the company's books) and has no relation whatever to the actual value of the stock.
Since the common stock, as a class, has claim to all of a company's resources after senior claims are met, common stock equity (the value allocated to the stockholdings on the company's books) consists of the total assets shown on the company's balance sheet, less all liabilities. It is essentially the company's net worth. This equity may be shown in the financial statement as the sum of the par value of the stock, capital surplus (the amount paid for newly issued stock above that nominal par value), and retained earnings (sometimes called earned surplus). The total stockholders' equity is divided by the number of shares outstanding to arrive at the book value per share—the theoretical value of the net assets behind each share on the company's books.
While book value can be one useful guide in assessing a company's shares, it is by no means a reliable measure of a stock's investment worth, and may bear little relation to the stock's price on the stock market. The assets used in the book value calculations may be worth more or less in the company's operations than the value on the books (e.g., a property may be worth far more than its ancient acquisition price or a plant may be obsolete), and in any case it's the company's future profitability that is most important in establishing investor value. And besides, investors (including expert financial analysts) may be wrong in their expectations of the future. From a practical standpoint, a stock at any point in time is worth what a buyer in the marketplace is willing to pay for it.
Because by nature common shares carry all the risks as well as potential rewards of ownership, they tend to fluctuate considerably more than other investment instruments such as good-quality bonds and preferred stocks. However, consistent with the notion of rewarding risk with higher returns, a large number of investment studies show that over the long run common stocks as a whole offer a higher investment return than other investment categories, and have demonstrated the greatest ability to outpace inflation over the decades. Thus, most experts agree that any long-term investment plan (especially for retirement) should rely heavily, but not exclusively, on common stocks.
Faeber. Esme. All aboout Stock.: From the Insicle Out. Chicago: Probus, 1995.
Hanson, Robert C., and Moon H. Song. "Ownership Structure and Managerial Incentives: The Evidence from Acquisitions by Dual Class Firms." Journal of Business Finance and Accounting, July 1996.
"Security Blankets." Mergers & Acquisitions. March-April 1997.