What Are Common Shares?
Common shares, often simply called common stock, represent an ownership stake in a company and are a fundamental component of equity investments. Holders of common shares are known as shareholders and generally have the right to vote on significant corporate matters, such as the election of the board of directors and major corporate actions. This type of security gives investors a claim on a company's assets and earnings, albeit a residual one, meaning they are paid after bondholders and preferred shareholders in the event of liquidation. Common shares are publicly traded on a stock market, providing liquidity and price discovery.
History and Origin
The concept of common shares and public ownership dates back to the early 17th century with the rise of global trading companies. The Dutch East India Company (Vereenigde Oost-Indische Compagnie, or VOC), established in 1602, is widely recognized for issuing the world's first public shares, effectively conducting the first initial public offering (IPO)9. This allowed the company to raise significant capital from a broad base of investors, pioneering the modern joint-stock company structure8. The VOC's shares were traded on what became the Amsterdam Stock Exchange, laying the groundwork for today's global financial markets and the trading of common shares. The Rijksmuseum, the state museum of the Netherlands, highlights the VOC as the world's largest trading and shipping company from 1602 to 1800, emphasizing its pivotal role in financial history7.
Key Takeaways
- Common shares represent an ownership stake in a corporation, providing holders with a claim on assets and earnings.
- They typically grant voting rights to shareholders, allowing participation in corporate governance.
- Investors in common shares primarily seek returns through capital gains from appreciation in share price and through dividends.
- Unlike preferred shares, common shares do not offer fixed dividend payments or priority in liquidation.
- The value of common shares is influenced by company performance, economic conditions, and market sentiment.
Interpreting Common Shares
The value and implications of common shares are interpreted through various financial metrics and shareholder considerations. For investors, the potential for capital appreciation and dividend income is a primary draw. The inherent voting rights associated with common shares give shareholders influence over the company's strategic direction and leadership through mechanisms like the election of the board of directors and approvals for major transactions.
Key metrics used to interpret the performance and value of common shares include:
- Earnings per share (EPS): This indicates how much of a company's profit is allocated to each outstanding common share.
- Price-to-Earnings (P/E) ratio: This measures a company's current share price relative to its earnings per share, indicating how much investors are willing to pay for each dollar of earnings.
- Dividend yield: For companies that pay dividends, this expresses the annual dividend payout as a percentage of the share price.
These metrics, combined with an understanding of the company's financial health and industry outlook, help investors evaluate the attractiveness of common shares as an investment.
Hypothetical Example
Consider "Green Innovations Inc.," a hypothetical public company that develops renewable energy technology. When Green Innovations Inc. decided to raise capital to expand its research and development, it issued 10 million common shares at an initial public offering price of $20 per share.
An individual investor, Sarah, purchases 500 common shares for a total investment of $10,000. As a common shareholder, Sarah now has proportional ownership in Green Innovations Inc. and can exercise her voting rights during the company's annual general meetings.
If Green Innovations Inc. performs well and its stock price rises to $30 per share, Sarah's investment would be worth $15,000 (500 shares * $30). This $5,000 increase represents a capital gains. Additionally, if the company declares an annual dividend of $0.50 per share, Sarah would receive $250 in dividends (500 shares * $0.50), providing an income stream from her common shares.
Practical Applications
Common shares are fundamental to modern finance and have several practical applications across investing, markets, analysis, and regulation:
- Investment Vehicle: Common shares are a primary investment vehicle for individuals and institutions seeking long-term growth and capital appreciation. They offer participation in the company's success.
- Equity Financing: Companies issue common shares to raise capital for operations, expansion, or debt repayment. This form of securities issuance is a crucial aspect of corporate finance.
- Market Benchmarking: Major stock indices, such as the S&P 500 or the FTSE 100, are composed primarily of common shares and serve as benchmarks for overall market performance.
- Corporate Governance and Control: The voting rights attached to common shares empower shareholders to influence company management and policies, including decisions on stock splits and mergers. Institutional investors, for example, often engage with companies on governance matters, as highlighted by the Council of Institutional Investors' policies which provide guidelines for publicly traded corporations5, 6.
- Share Buyback Programs: Companies frequently repurchase their own common shares from the open market, which can increase earnings per share and return capital to shareholders. For instance, S&P Dow Jones Indices reported that S&P 500 companies executed $215.5 billion in share repurchases in Q1 20233, 4.
Limitations and Criticisms
While common shares offer significant benefits, they also come with inherent limitations and criticisms. A primary drawback is that common shareholders are the last in line to receive payment in the event of a company's liquidation or bankruptcy, after creditors and preferred shareholders. This makes common shares riskier than debt instruments or preferred stock.
Another criticism revolves around the potential for management actions that may not align with the long-term interests of common shareholders, particularly in cases where executive compensation is tied to short-term stock performance. Issues like dual-class share structures, where certain classes of common shares carry unequal voting rights, can also concentrate power in the hands of a few, potentially diluting the influence of other common shareholders. The Council of Institutional Investors, an advocate for effective corporate governance and strong shareholder rights, has voiced concerns about practices that diminish investor rights and protections, including the proliferation of arrangements that misalign voting rights and economic ownership1, 2. Furthermore, market volatility can lead to significant fluctuations in the value of common shares, exposing investors to substantial risk of capital loss.
Common Shares vs. Preferred Shares
The distinction between common shares and preferred shares is crucial for investors. While both represent ownership in a company, they differ significantly in their rights and characteristics.
| Feature | Common Shares | Preferred Shares |
|---|---|---|
| Voting Rights | Typically include voting rights | Generally do not include voting rights |
| Dividend Payments | Variable, not guaranteed, paid after preferred | Fixed, typically guaranteed, paid before common |
| Claim on Assets | Residual claim, paid last in liquidation | Higher claim than common, paid before common |
| Potential Return | Higher potential for capital gains | Less potential for capital gains, more income-focused |
| Price Volatility | Generally more volatile | Generally less volatile |
Common shares offer the potential for greater capital appreciation and voting rights, providing shareholders a voice in the company's operations. However, this comes with higher risk regarding dividend payments and asset claims during liquidation. Preferred shares, conversely, prioritize income stability and asset claims but forgo voting influence and typically offer less upside potential.
FAQs
What is the primary difference between common and preferred shares?
The main difference lies in voting rights and dividend priority. Common shareholders usually have voting rights and receive variable dividends (if any), while preferred shareholders typically have no voting rights but receive fixed dividends and have a higher claim on company assets in liquidation.
How do common shares generate returns for investors?
Investors in common shares can generate returns in two primary ways: through capital gains, which is an increase in the share's market price, and through dividends, which are portions of the company's profits distributed to shareholders.
Do all common shares have voting rights?
While most common shares come with voting rights, some companies might issue different classes of common stock where certain classes have more or less voting power per share. This is often seen in companies where founders wish to maintain control.
Can a company buy back its own common shares?
Yes, a company can engage in a share buyback, also known as a share repurchase, where it buys its own common shares from the open market. This can reduce the number of outstanding shares, which can increase earnings per share and potentially the stock price.
What happens to common shareholders if a company goes bankrupt?
In the event of a company's bankruptcy or liquidation, common shareholders have the lowest priority claim on the company's assets. Creditors and preferred shareholders are paid first, meaning common shareholders may receive little to no value for their investment.