By Aniket Bose. Edited by Arjun Chandrasekar.
Stocks are primarily an investment in a corporation that grants a shareholder certain ownership rights. They are shares into which a corporation’s ownership is divided. A single share of stock represents a fractional ownership of the corporation in proportion to the total number of shares. Companies sell stocks of their shares in order to help them raise money for business operations.
There are two main types of stocks: Common and Preferred stock. Let’s understand each one in depth.
These stocks are a form of corporate equity ownership, known as a type of security. Other names for common stocks are voting shares and ordinary shares as well, but the term common stock is mostly used in the United States. The advantages of common stocks include: equity ownership which provides the highest rate of return for the long term; it’s more than bonds and cash. The risks of common stocks include: owners of common stock don’t have any guarantees, but investors are accepting the risk in exchange for possible greater gains compared to other safer investments. For instance, say a company had 100 shares of common stock but they sold it to investors for raising money for the company. Out of those 100 shares, one share would be equivalent to one percent ownership of that company.
Preferred stocks are a form of stock which may have any combination of features that are not possessed by common stock including properties of both an equity and a debt instrument. It is generally considered as a hybrid instrument. It’s a special type of stock that pays a set schedule of dividends and it does not come with any voting rights. It is a combination of aspects from both common stock and bonds in one security, including regular income and ownership in the company. Preferred stocks are issued with a fixed par value and the dividends they pay are usually based on a percentage of that par, and it’s mostly at a fixed rate. The market value of preferred stocks are sensitive to changes in interest rates. For example, the holder of 100 shares of a company’s 8% $100 parred stock will make the investor receive annual dividend payments of $800 (8% * $100 = $8 per 100 shares) before the common stockholders are allowed to receive any cash dividends for the year.