By purchasing shares included in common stocks of a company, you're entitled to proportional ownership, or what we call in stock market terms, as equity, in the company. To understand it through simple maths, consider that a company XYZ is issuing its 100 common stock shares in the market. If you purchase 10 shares of XYZ company, then you'll be able to own 10% of the company!
Besides this, there are some other advantages of common stocks, that can make you feel great as an investor. The fact that shares in a common stock give you an opportunity for proportional representation in the public company, may lead you to assume that you have fair chances of high returns in the company. Well, truth to be told, common stocks are not so simple when it comes to returns. As an intelligent investor, be informed about both facets of common stocks and make wise investment decisions.
Advantages of Common Stocks
Right to Vote in Issues of the Company
After buying shares in a common stock, you're entitled to speak in the matters of the company. For every share you purchase in the common stock, you're awarded a vote. You may be asked to vote for electing the board of directors in the company or in decisions regarding mergers and acquisitions. Higher the number of shares you've in common stocks, more will be your voting power.
High Dividends on Increased Market Value
Since you have a partial ownership of the company, you will be awarded dividends and profits with the increase in market value of the company stock. If the company performs extremely well and it becomes more valuable, you will be able get capital gains, that are a measure of the worth of the company. Similarly, in case, company profits by its business, it may decide to benefit its common stockholders by giving individual dividends or payments in the form of cash or stocks.
Lowered Financial Risks Relative to Fixed-Income Investments
It is a fact that stocks are not as adversely hit by harsh economic conditions or inflation as fixed income securities like bonds. If you view history of stocks during times of moderate inflation, you'll find that stocks may have slowed down in their performance during difficult market conditions but they never perform worst. The net effect of inflation rates is heightened in fixed income securities than in stock investment.
Preemptive Rights Remain Intact
One of the best advantages of buying shares in the common stocks is that the individual proportional ownership rights are never challenged. To make it more clear, let us suppose that you have 10% ownership rights in a company. To raise capital, if there is an issuance of common stock in the company and it releases 100 more shares in the market, then you can buy 10 new shares even before they're issued to the public. This step doesn't dilute your ownership in the firm even if new shares are being introduced in the market. Your share of ownership in the company remains same the always.
Easier and Quicker to Trade Due to High Liquidity
Common stocks are the most common (the name itself says it all) shares and they're easier to buy and trade, without any restrictions. Young, old, stock market savvy, a beginner investor - anyone can buy and trade them. Large corporations trade frequently and you can buy or sell shares of big companies almost every day; however, you won't find such trends in shares of small companies.
Minimum Legal Complications
As an individual investor, you're not legally obliged for action taken by the company management except for your financial investment. Being a stockholder, you've got minimum legal liabilities for any wrongdoings or fraud of the company.
Disadvantages of Common Stocks
Erratic Fall in Market Price
The functioning of markets is very speculative and sometimes, even without some major reasons, there is a drop in prices of the shares. A simple rumor in the market about the performance of the company can lead to fall or increase in share prices. As such, nobody can be sure about how the market will turn out to be at the end of the day. Erratic nature of the market can be very demotivating for investors
Downsizing of Dividends
It is a fact that dividends of shareholders are cut in harsh economic times and that is one of the biggest demerits of common stocks. If not due to recession, dividends or capital gains may not be given to shareholders because of the poor performance of the company.
Common Stockholders Are the Last Priority
In case of failure of the company, common stockholders are given the last priority. That's why it is said that those owning common stocks suffer the most during times of bankruptcy or failure of the business. Only after a company is done with all issues like paying employees, creditors and managing taxes, the owners are entitled to get paid.
Limited Rights of Common Stock Shareholders
Though it may appear extremely lucrative to have purchased common stocks, in practicality, it may not always be so. Information regarding a company's performance that is given in the annual reports and is uploaded on the official websites is very complex for a common shareholder to understand. Media news besides the complexity of the stock industry makes it even more difficult to take effective investment decisions. Similarly, no matter shareholders are regarded to be the "company owners", they don't have exact rights and powers as that of the CEO or board of directors.
All these factors eventually lead to lack of understanding in investments. Most of the common investors or individuals hence merely rely on third parties or agents for consultations on investments. Small share holders rarely have any say in the company matters as it is entirely dominated by the large shareholders and those who own the maximum share. So if you're just an average common stock shareholder, your vote may not even reach in the hierarchical board rooms of corporate America.
Taxes are Cut on Capital Gains
Capital gains are liable to tax cuts. If the shares of common stock perform fairly well, you're awarded capital gains by the company. You're expected to pay some tax on the awarded capital gain. This is applicable for shares that have been held for more than one year. The tax rates are variable and keep on fluctuating every year. You can visit the Internal Revenue Service (IRS) website for more details about the tax laws and rules applicable on capital gains.
Going through the advantages and disadvantages of common stocks must have made you aware about both sides of the story. In general, when you hear that stocks are trading high or low, it is the "common stocks" that are being referred to. Common stocks are very profitable theoretically, but to make that happen, you must have a deep understanding of stock market investing and fair amount of luck.
Studying about common stocks and learning to trade in it can gradually make you a master of it. Since most of us don't have enough time to involve in full-time stock broking or share works, it is ideal to take help from expert and authentic stock brokers, who in turn will charge you some fee for their services. In case, you're comfortable carrying out the stock trading task on your own, you can begin it any time.