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What is common stock?
Common stock is a type of stock issued to the majority of shareholders in a company. Holders of common stock enjoy certain rights that their counterparts in preferred stock holders do not. Rather than receiving regular payouts, common stock holders derive value from their shares when the company grows.
Common stock is what most people picture when they think “stock,” in that it makes up the vast majority of a company’s shares. For a privately held company, all those shares are owned by company personnel. If it goes public, however, anyone can purchase common shares and own some small proportion of the company.
Common stock confers shareholders with voting rights. One share is roughly equivalent to one vote, meaning that people with more shares have a much larger say in the company’s business operations, such as electing a person to its board of directors. For that reason, owners of a company usually hold common stock, while major investors hold preferred stock, which doesn’t come with voting rights.
Common stock frequently generates dividends, but, unlike preferred stock, they are not guaranteed. Instead, the value of common stock comes from the health of the issuing company: if the company makes a profit, their stock is worth more, and it can reinvest that revenue and create growth. However, that makes common stock riskier than preferred stock, because if a company’s profits fall, the investor loses money. Still, although she’s not guaranteed a return on her investment the way preferred stock holders are, an investor in common stock stands to benefit much more in times of growth.
On the other hand, in times of financial distress, common stock holders have the most to lose. If the company needs to liquidate its assets, common stock holders are the last to get paid. First are its regular creditors and bondholders, followed by preferred stock holders.
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Common stock example
FriendSpace is a social media app whose parent company, FriendSpace Inc., has enough funding to go public. The company is made up of 10,000 shares, of which 9,000 are common and 1,000 preferred. Its board releases 3,000 common shares in an initial public offering (IPO), which a handful of major investors snap up. Their shares increase in value on the second day of trading, and some of the investors sell them off for a profit, while others hold onto their shares and plan to exercise voting power in an effort to improve the company and generate growth.