Common stocks are securities that give you equity ownership in a corporation. As a common stocks holder, you will have voting rights and a share of the company’s dividends and/or capital appreciation. As a mere investor, however, you are at the bottom of the priority ladder. If the company goes bankrupt, you will only receive your money after debt holders, bondholders and preferred stockholders have been given their share.
This makes common stocks riskier compared to preferred stocks or debt shares. But because it performs better than bonds and preferred shares over time, it provides certain advantages. This only shows that common stocks are associated with pros and cons. How good or bad the situation is for you, depends on which side of the spectrum that you are in — whether you are investing on common stock or issuing it.
List of Advantages of Common Stocks
1. Yield huge gains.
As already mentioned, common stocks often outperform bonds, deposit certificate and other types of investment products. As they are guaranteed, what you stand to gain has a minimum and a maximum. Common stocks, on the other hand, have no limits to the amount of money that you will gain. Although there is always a risk of losing, you are also guaranteed of earning large gains. This is something every investor wants and needs.
A company issuing common stocks in the financial markets use them as an alternative to debts, as it is a less expensive route. Unlike debts, an issuer of common stocks is not obligated to pay interest to investors, only discretionary payments on dividends in the event that the company has extra cash.
2. An ideal investment.
With this type of financial vehicle, you are only allowed to invest with limited liability. That is, whatever amount you invested initially would be the most that you will lose in the event of liquidation. And because you purchase common stocks on cash basis, you can put a cap on the amount of money to invest. Compared to leverage transactions, you are not at risk of losing money that exceeds the total funds you have invested.
3. Legal liabilities are restricted.
Since you are a passive holder of common stocks, your liability to a company is limited. Whatever problems that arise outside a stockholder’s financial investment, you will not be affected. Only the people running the company would have to face the consequences. The only thing you should be worrying about is the company’s health. As long as it is earning and moving on an upward trend, your investment and financial future is safe.
4. Easy buying and selling process.
As this type of investment is liquid, you have the option to sell it any time you want, or buy more if you wish to grow your stocks. What is even better is that common stocks can be purchased at a fair price.
5. There are two ways to gain benefits.
Capital gains and dividends are two ways to earn from stocks. Each stock you own gives you a cut of whatever a company earns since you are a partial owner. If the value of the stock appreciates, so will the capital gains. If the business’s earnings go beyond what it needs to cover maintenance and growth, it has the option to distribute the excess to holders of common stocks, or make dividend payments.
List of Disadvantages of Common Stocks
1. High risk investment.
Risks are always associated with investing, but more of these are linked to common stocks. Their prices are volatile, fluctuating erratically. If you panic every time the price goes down and sells your stocks, you could end up losing more. The value of the stocks can also change without warning, making it difficult to evaluate their performance even if the company is doing well. Worse, if the business goes bankrupt, you can say goodbye to your investment.
2. Lack of control.
Buying stocks from a company is a tricky situation. Your success practically depends on whether or not a business has excellent practices and strategies. Since you have no right to demand a copy of their books or business plans, you would have to do your research in other ways. As a shareholder, you are also subject to the will of stockholders. You cannot join in the decision-making process or suggest a better way of doing things. Therefore, if stockholders don’t do their jobs well, you could go down with them. This is why it is vital that you perform due diligence before you invest.
There is one way to have some control, however. You have to buy a significant amount of shares to gain a majority in the investment. Unfortunately, not everyone will be able to afford this. Moreover, companies usually put a cap of the number of common stocks they sell to keep the control of existing shareholders strong.
3. Last one to get paid.
This is probably the biggest downside of common stocks. As previously mentioned, if a company liquidates, you would not get paid until those that rank high on the priority ladder gets their share. Good enough if you get to pull out your stocks just in time. But because stocks don’t always behave as consistently, anticipating its performance would be difficult. You can only hope that you do get paid, after everyone else does, including the creditors, employees, suppliers and taxes.
On the side of an issuing company, selling too many common stocks can have a negative impact on the existing shareholders. It is bad news if the business keeps increasing its outstanding shares. According to the Wall Street Journal, the ownership of shareholders and voting influence will diminish when the stocks enter the market.
When it comes to common stocks, getting the companies right is just as important as getting the price right. The best combination would be to buy stocks at a fair price from a company with a strong and longstanding reputation in the market. Unfortunately, the stock market is not always cooperative. Or make that rarely cooperative. This is why timing and research are very important.
Natalie Regoli, Esq. is the author of this post and the editor-in-chief of our blog. She received her B.A. in Economics from the University of Washington and her Masters in Law from The University of Texas School of Law. In addition to being a seasoned writer, Natalie has almost two decades of experience as a lawyer and banker. She is a child of God, devoted wife, and mother of two boys. If you would like to reach out to contact Natalie, then go here to send her a message.