What are Common Stocks?

Last Updated: 23 Jan 2024

Investing in the Indian stock market is one of the most popular ways adopted by people looking to attain financial freedom. These people, also known as investors, invest their capital in various stocks of fundamentally good companies to achieve their financial goals. Although making profits seems like the main objective for anyone who enters the stock market, it is generally not the case. Most investors who believe in value investing buy good stocks only to hold them for the long term. Here, the goal is a capital appreciation by increasing the price and earning a steady income through dividend payouts.

One of the best things about the equity class is its ability to offer investors a host of options to diversify and allocate their capital based on their goals and risk profile. For example, an investor looking to make profits in the short term can invest in growth stocks. Notably, investors who know they will hold the stocks for the longer term choose a category of stocks called common stock.

This blog details everything about common shares, and common shares meaning to help you comprehensively achieve your investing goals. But first, let’s understand the idea of shares.

What are Shares?

In simple words, a share indicates a unit of ownership of a particular company. If you own shares of a company, it implies that you, as an investor, own a percentage of the issuing company. These shares are listed on the stock exchanges through an Initial Public Offering, and investors can buy and sell them based on their current price.

If you buy the shares of a company, you become the owner of the company in the proportion of the percentage of the purchased shares. From the day you buy the shares, you are a shareholder. As a shareholder, you are entitled to receive a portion of the profit of the company. This amount is called the dividend, and the company declares it as per its financial performance. The shareholders can sell these shares anytime they want to another investor who would then become the shareholder.

What are common shares of common stocks?

Common stocks are securities that reflect the ownership of investors in a company. Once you hold the common stocks of a company, you are entitled to elect the board of directors of the company and have voting rights. These voting rights allow you to be a part of the company’s internal decision-making and vote on various company policies.

Common shares allow investors to realize better returns in the long term through higher yields. However, in case the company decides to liquidate, common stockholders have rights to the company’s assets only after the company repays the preferred shareholders, bondholders, and other debtors in full. For the company’s balance sheet, the common shares are reported in the equity section of the balance sheet.

Features of the Common Shares

Common stocks come with various features that make them attractive to investors which include:

• Ownership: The common stocks reflect the ownership of the investors in the company. For example, if you hold 1,000 common shares of a company, you are the owner of the company in the same proportion of its percentage value.
• Powers: Common stocks allow investors to have various powers, such as electing the board of directors and voting on internal policy matters.
• Transaction: Common shares are also bought and sold similar to other stocks. Investors need a Demat and trading account to buy and sell common shares.
• Exchange: Common shares are listed on the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE), just like other types of shares.
• Repayment: Common stocks and the common shareholders are not paid at the time of liquidation of the company but after preferred shareholders, bondholders, and other debtors.

Understanding common shares: Why are common stocks issued?

The story of common stocks started in 1602 when the Dutch East India Company introduced them and listed their common shares on the Amsterdam Stock Exchange. Now, common stocks are widely traded in India on the National Stock Exchange and the Bombay Stock Exchange under the regulatory umbrella of SEBI.

Investors prefer common shares because of the powers they bring and their ability to allow for better returns in the longer term. For example, if you are the common shareholder of a company, you can attend the meetings of the company and vote on various potential policies the company is considering. You can protect your investment in the company in case the company policy is negative. However, common shares are considered risky because of their inability to legally bind companies to repay common stockholders before other types of shareholders. In case the company goes bankrupt, it may be that the common shareholders do not get their capital investment back if the company does not have enough assets.

But, the downside is sidetracked due to common stocks consistently outperforming various stock market benchmarks and offering higher profits to the investors. Common shareholders are also entitled to dividend payout, making common stocks a lucrative investment option that offers the dual benefit of long-term capital appreciation and steady regular income.

But, why do companies issue common shares?

Companies issue common shares because of the following reasons:

• Expansion: Companies can increase their goodwill and profits by expanding their business further. As it allows companies to capture increased market share, they raise funds by issuing common shares and use the money to achieve their expansion goals.
• Acquisitions: One of the best ways for a company to expand is by acquiring a competitor or a promising company that is in the same sector. As acquisitions can be very expensive, companies issue common shares to fund the purchase.
• Paying off debts: Almost every company borrows money to fund the initial stages of their company’s business cycle. After stabilizing their business activities, they have to use their revenue to pay off the debt. However, companies may issue common shares to raise money to pay off such debts in one go.
• Cash reserve: Similar to an individual saving for an emergency, companies also make a cash reserve for an emergency event. Since it is frowned upon to use profits for such purposes, companies issue common stocks and use the money to make a cash reserve for future use.

Benefits of Common stocks

Here are the benefits of common shares:

• Better returns: In the case of common shares, there is no limit on how much a common stockholder can earn. Investors can hold common stocks for as much time as they prefer and earn constant returns. Furthermore, common stocks are less expensive and risky when compared to other debt instruments.
• Voting Rights: Investors love voting rights as it allows them to be a part of the company’s decision-making process. Since their returns are directly related to the company policies, voting rights ensure their investment is protected and moves in a positive direction.
• Limited Liability: Common shares allow investors to enjoy steady returns but avoid any other legal liabilities. If the company is generating good profits, common shareholders are entitled to dividend payments but are not held liable if the company is making losses or decides to liquidate.

Common shares can be an effective way to realize good returns on investments for investors who are looking for a long-term investment. However, it is advised that you do your due diligence before choosing a company, as in the event of liquidation, you may have to realize a high risk. If you are looking to invest in common shares, you can open a free Demat and trading account at IIFL. All you have to do is visit the IIFL website or download the IIFL Share market app from the app store.

Frequently Asked Questions

Why are common stocks issued?

The main purpose of companies to issue common stocks is to raise enough money to fund a business activity. The business activities may be expansion, acquisition, paying off debt or creating a cash reserve for future use.

Who should invest in common stocks?

Common stocks prove effective for investors who are looking for a long term investment and steady returns through dividend payouts. As common stocks are not highly volatile, investors benefit from holding them for the long term. If you are looking for a short term investment, common shares may not be the ideal investment for you.