What Is Common Stock?

Definition & Examples of Common Stock

The fundamental aspects of common stock

The Balance / Lara Antal 

Common stocks are shares of ownership in a corporation that afford their holders voting rights. They vary from preferred stocks in two key ways. Shareholders who own preferred stocks receive dividend payments before shareholders of common stocks, but preferred stocks do not come with voting rights.

What Is Common Stock?

Stocks are traded on stock markets. In the U.S., the most common of these are the New York Stock Exchange and the Nasdaq Stock Market. That makes stocks liquid as well as easy to price. As a result, they are excellent indicators of the underlying value of the assets.

Common stocks allow shareholders to vote on corporate issues, such as the board of directors and accepting takeover bids. Most of the time, stockholders receive one vote per share. Stockholders also receive a copy of the corporation's annual report.

Many corporations also give stockholders dividend payouts. These dividend payouts will change based on how profitable the company is.

How Common Stock Works

Stocks are bought and sold throughout the day on stock exchanges, and the price of a share of a stock goes up or down depending on the demand. Individual stock prices are affected by corporate earnings and public relations announcements. All stocks are affected by the health of the U.S. economy overall.

You earn money from stocks in two ways: from dividend payments or by selling the stock when its price goes up. Of course, you also can lose your entire investment if the stock price plummets.

Expected earnings drive demand for a stock. If investors think a company's earnings will rise, they will bid up the price of its stock, especially if the current price is low compared to the company's earnings, as measured by the price to earnings ratio.

Expected growth of revenue also impacts the price, even if the earnings aren't there yet. This can happen with a new company that has a lot of promise.

Stocks are first issued in a company's initial public offering. Before an IPO, companies typically are privately held. By going public, such companies can expand by generating capital received in an IPO.

Alternatives to Common Stock

One of the most common alternatives to buying individual stocks is investing in mutual funds. Such funds are collections of securities such as stocks and bonds that are professionally managed. This is an easier way to establish a diversified retirement account, for example, for those without the time or desire to manage their own portfolios.

Other common alternatives include exchange-traded funds and bonds. ETFs are similar to mutual funds except they are traded on stock exchanges. Bonds are a means for corporations or municipalities to raise funds. By purchasing a bond, you effectively are lending money to whoever is selling the bond in exchange for a specified rate of interest on top of the bond's value when it matures.

Do I Need to Pay Taxes?

Profits from stock transactions are considered capital gains and taxed based on whether the income is classified as a long-term gain or a short-term gain. Profits come about when stocks are sold for more than their purchase price. The profit is considered a short-term gain if the asset was held for less than a year. Any profit from an asset held for a year or longer before it is sold is considered a long-term gain.

In most instances, tax rates for long-term capital gains are more favorable than the rates for short-term gains, meaning it often is beneficial to hold on to an asset for at least one year before selling it for a profit.

Short-term capital gains are taxed at the same rate as ordinary income. For example, if you earn $75,000 from your job and another $5,000 from short-term capital gains, your income would be $80,000.

Long-term capital gains are subject to tax rates of 0%, 15%, or 20% depending on filing status and the amount earned.

Common Stock vs. Preferred Stock

Shareholders who own preferred stock do not have voting rights, but they do receive set dividends that do not change before a corporation calculates how much to spend on common stock dividends.

If a company goes out of business or is restructured in a bankruptcy, the assets are distributed to bondholders first. Preferred stockholders are next, and common stockholders are last. In most cases, common stockholders will receive nothing.

Common Stock Preferred Stock
Voting rights Fixed dividend payments
Least likely to receive assets if a corporation goes under Priority over common stock
   

Key Takeaways

  • Common stock comes with voting rights.
  • Preferred stocks have higher priority when it comes to dividend payments.
  • Money earned from selling stocks is taxable, but rates are more favorable if assets are held at least one year.

Article Sources

  1. U.S. Securities & Exchange Commission. "Stocks." Accessed Sept. 11, 2020.

  2. IRS. "Topic No. 409 Capital Gains and Losses." Accessed Sept. 11, 2020.