What Are Common Shares? (And How to Get Started)
Common shares, also known as common stock, are a type of security that represents ownership, or equity in a company. Common shares can be purchased by individual investors on a stock market, such as the Toronto Stock Exchange (TSX), the New York Stock Exchange (NYSE), or the Nasdaq.
How Do Common Shares Work?
The name ‘common shares’ suggests that there are different types of shares, which is indeed true. We’ll get into that a bit later, but first, let’s take a closer look at how common shares work.
Common shares are bought and sold on the stock market during open hours. Share prices fluctuate up and down based on investor demand. In other words, the market dictates the price of shares. Of course, demand is influenced by several factors, such as a company’s financial performance, industry outlook, and company news, whether it’s negative or positive.
The Rights of Common Shareholders
Common shareholders have the right to vote at special meetings, usually to elect board members or decide on major company policy decisions. In most cases, shareholders receive one vote for every share owned. Because board members are the ones making the big decisions, voting gives common shareholders some control over the direction of a company.
In addition to voting rights, common shareholders can receive dividend payments when issued by the company. Dividends provide another income source for shareholders, over and above the capital gains realized when a stock goes up in value. Not all companies pay a dividend on common stock.
Preferred Shares vs. Common Shares
As I alluded to earlier, there is more than one type of stock an investor can buy. Preferred shares are different from common shares in that they do not offer voting rights. But while preferred shareholders lack control over a company’s direction, they have priority when it comes to the distribution of company assets and earnings. Preferred shareholders often have the option of converting their shares into common stock, while the reverse is not true.
Unlike with common shares, preferred share dividend yields are set in advance and are paid out before common share dividends. If a company goes bankrupt, the assets are distributed to preferred shareholders before common shareholders. Preferred dividends tend to be worth more than common dividends.
How to Make Money with Common Stocks
There are two ways you can make money with stock. The first is through capital appreciation, when the stock goes up in value. For example, if you purchase a stock at $50/share and then sell it at $75, you’ve earned $25 for each share that was sold. This type of income is called a capital gain.
In addition to capital gains, many common stocks pay dividend income. A dividend is a cash distribution from the earnings of the company, paid on a quarterly basis. Common stock dividends are variable, with the amount decided upon by the company’s board of directors. The ability to earn dividends is one of the things that make stock investing so attractive because they allow investors to continue to earn, even when the price of a stock drops and the value has gone down.
How to Get Started with Common Stock
Buying individual stocks is not for everyone. There is an increased risk in having your money invested in one, or just a few companies. To attain proper diversification with stocks, you’ll need to have a large sum of money invested in several companies across a variety of industries. Not only that, it takes time to do the proper research on any company’s stock before you decide to buy. Not everyone is up for that.
Common Stock and Mutual Funds
If you are new to investing, or you only have a small amount to invest, there are other ways to buy common stock. One is to purchase a mutual fund, which is like a basket of securities holding a variety of stocks and bonds. Mutual funds are professionally managed and are an easy way to achieve instant diversification without requiring large sums of money. The downside to mutual funds is that most are expensive to own and charge an annual management fee of more than 2%. High fees dilute your returns over the long term.
Common Stock and ETFs
A more affordable way to buy common stock is with Exchange Traded Funds, or ETFs. ETFs are similar to mutual funds in that they hold a large number of underlying securities, however, they are passive investments requiring less oversight. As a result, the fees charged by an ETF are much lower than a mutual fund.
ETFs are traded like common shares and can be purchased instantly on the stock market throughout the day. Mutual fund orders are filled once per day and are based on a fund’s closing unit price.
Where Can I Buy Common Stock?
Stock is issued by companies through an Initial Public Offering (IPO). This provides important capital that can be used for expansion. There are specific steps companies must take to receive approval for the IPO. Eventually, the shares are introduced to the market and made available for purchase on the stock exchange.
Whether it’s individual stock, mutual funds, or ETFs, the easiest way to buy common stock is by opening a discount brokerage account and trading online. All of the big Canadian banks have their own brokerage, or you can choose to go with an independent broker, such as Questrade or Wealthsimple Trade. Our top choice here at MapleMoney is Questrade, because of their robust trading platform, excellent customer service, and low fees, which includes free ETF purchases.
Different Classes of Stock
In addition to preferred and common shares, many companies issue different classes of stock. The main purpose for doing this is to ensure that certain investors get preferred voting rights. For example, a company may issue Class A shares and Class B shares, each of which has different voting rights. Different classes of shares are listed separately on the stock exchange, each with a slightly different ticker symbol.
Characteristics of Common Stock
To summarize what we’ve learned about common stock, here is a list of its main characteristics:
- Most popular type of stock
- Issued via Initial Public Offering (IPO)
- Usually outperforms preferred stock, but is considered higher risk
- Bought and sold on the stock market
- Prices fluctuate, based on market demand
- Shareholders are given voting rights
- Shares cannot be converted into preferred shares
- Common shareholders have lowest priority (behind preferred shareholders)
Should I Invest In Common Shares?
Regardless of where you are in your investment journey, common stocks can be an important part of your portfolio. No other type of security offers the same potential for capital appreciation over the long term. That said, growth potential must always be balanced against your individual risk tolerance.
All stocks fluctuate in value and their returns are never guaranteed. When buying stocks, there is always the possibility that you will lose your money. This is why common stock is best owned as part of a well-diversified portfolio. Of course, you should always consult with an investment professional to determine how common stocks can fit in your portfolio. Once that’s done, the best thing you can do is get started.