First-time and even intermediate stock investors will be confronted with a range of stocks to choose from. Common stocks collectively represent one of the two types of stocks based on rights and privileges granted by issuing companies is common stocks.
Similar to preferred stocks, holding these stocks represents fractional ownership of the issuing company. However, compared with its counterpart, common stocks grant their holders the right to elect the board of directors and vote for corporate policies.
Pros: The Advantages of Common Stocks
Common stocks are generally ideal for aggressive investors who are seeking to grow their wealth through long-term capital appreciation. It is fundamentally suited for passive investing and long-term buy-and-hold investment strategies. The following are the specific benefits or advantages of investing in common stocks:
• Voting Rights: Purchasing and holding common stocks grant common stockholders the right to participate in the direction of the issuing company via electing its board of directors and voting for corporate policies to include strategies, resolutions, mergers and acquisitions, and other companywide organizational changes.
• Capital Appreciation: Another advantage of common stocks, especially when compared to preferred stocks, is that their value can dramatically increase as the issuing company grows bigger and becomes more profitable and valuable. Imagine holding common stocks of Amazon and Apple since the 1990s.
• Long-Term Investing: Common stockholders can receive enormous returns over time because the value of their investments has a better potential to appreciate than preferred stockholders. Common stocks are ideal for aggressive investors seeking long-term investment growth through passive and buy-and-hold investing strategies.
• Ease of Investing: Investing in stocks is easier than opening bank accounts or purchasing real estate. The same is true for common stocks. Investors can purchase them on different trading platforms available online. They can also choose to work with a financial advisor or a portfolio manager to guide them with their investment decisions.
• Limited Liability: Holding common stocks does not expose the personal assets of common stockholders to the possible liabilities of issuing companies while also giving them some capacity to participate in major corporate directives. The risk is limited to the amount invested in purchasing these stocks.
• Trading Advantages: Mid-cap and large-cap common stocks are usually traded in large volumes, thus resulting in lower bid-ask spreads and faster trade transactions. Trades can also enjoy margin trading and short-selling for eligible common stocks, as well as options in some cases to hedge against market volatility.
• Liquidity: The same trading advantages also translate to the fact that common stocks are considerably more liquid than other assets or securities. Investors can readily sell them for cash or alter their existing investment portfolio according to newer investment goals. Note that liquidity is one of the major advantages of investing in stocks.
From the perspective of companies, common stocks allow them to raise capital for expanding their businesses or funding other expenses. Issuing them also allows these companies to dilute the power and influence of existing shareholders.
Cons: The Disadvantages of Common Stocks
The problem with common stocks is that although they represent fractional ownership in a particular company, they also represent a residual claim to its current and future profits. This means that in case of liquidation, common stockholders are paid last after creditors, bondholders, and preferred stockholders. Below are its specific drawbacks or disadvantages:
• Market Volatility: The stock market is volatile. Both common stocks and preferred stocks are volatile. However, between the two, common stocks are historically characterized by frequent price swings within a given trading session. This makes it not ideal for investors and traders seeking short-term gains.
• Other Risks: Common stockholders are exposed to all of the risks in stock investing. Some risks are more prominent in common stocks than in preferred stocks. These include management risk that arises from problems due to poor management and business cycle risk that comes with the expansion-recession phases of the economy.
• Residual Claim: Remember that one of the biggest disadvantages of common stocks is that they represent a residual claim over the current and future profits of the issuing company. Common stockholders are paid last. There are instances when companies do not enough funds to pay these investors.
• Limited Dividends: Preferred stockholders have a higher claim on distributions and as such, as entitled to dividends that can provide them a regular stream of passive income. Some common stocks also pay dividends but this is not the default. Dividends are not guaranteed unless the issuing company generates higher profits.
• Non-Conversion: It is also important to note that some companies issue preferred stocks that can be converted to common stocks. These are called convertible preferred stocks. Common stocks do not have this option. Once purchased, common stockholders cannot convert their common stocks into preferred stocks.
• Several Classes: Companies can also issue different classes of common stocks such as class A, class B, and class C stocks. For example, class A common stocks confer 100 votes per share while class B common stocks confer 1 vote per share. Stockholders of class C stocks have fewer voting rights and can experience liquidity issues.
The aforementioned disadvantages make preferred stocks more appealing than common stocks to certain investors. In addition, from the perspective of companies, issuing preferred stock confers specific advantages that center on enabling them to raise capital for business expansion or fund their operations while warding off potential hostile takeovers.