Investing in common stocks

What are common stocks?

Common stocks, also known as common shares or ordinary shares are ownership shares in a company. When you buy common stocks, you become a partial owner of that company. These stocks represent a claim on the company's assets and earnings. As a shareholder, you may have the right to vote on certain company matters and may also be entitled to a share of the company's profits in the form of dividends.

Common stocks are traded on stock exchanges, such as the New York Stock Exchange. Their prices fluctuate based on supply and demand, as well as the overall performance of the company. If the company performs well, the value of its common stocks tends to increase. On the other hand, if the company performs poorly, the value of its common stocks may decrease, resulting in potential losses for investors.

History of common stock

The idea of common stock has been around since the early 17th century when modern corporations first emerged. One of the earliest examples of common stock can be seen in the Dutch East India Company (VOC) in 1602. The VOC was the world's first publicly traded company, selling shares to investors and introducing the concept of investing in businesses through ownership shares.

By issuing common stock, the VOC was able to raise funds for its ambitious projects, like trading spices and establishing colonies in Asia. People who bought these shares became co-owners of the VOC and were entitled to a portion of the company's profits. The VOC's common stock was bought and sold on the Amsterdam Stock Exchange, offering liquidity to shareholders.

The success of the VOC and its common stock paved the way for the modern stock market and the use of common stocks as an investment product. Since 1602, common stocks have become a popular choice for investors looking to be part of the growth and success of companies around the world.

Why is common stock called equity?

Common stock is known as equity because it signifies ownership in a company. Equity refers to the ownership interest or the remaining claim on a business's assets and earnings. Common stockholders are regarded as the true owners of a company since they have a claim on the company's assets and earnings after all other stakeholders (like debt holders and preferred stockholders) have been compensated.

The term 'equity' highlights the fact that common stockholders possess an ownership stake in the company and hold an equity interest in its value. Unlike debt holders, who have a fixed claim on the company's assets through loans or bonds, the ownership interest of common stockholders can fluctuate in value based on the company's market performance.

Additionally, common stockholders have certain rights and privileges, such as voting rights in corporate matters, which further emphasises their ownership status and their ability to participate in decision-making processes. Therefore, common stock is referred to as equity because it represents ownership and the remaining claim on a company's assets and earnings.

Why do companies issue common stock?

Companies issue common stock for example as a way to raise capital. By selling shares in their company, they can generate funds to finance business operations, invest in growth opportunities or pay off debts. Additionally, issuing common stock allows companies to share the risks and rewards of ownership with investors.

Differences between common stocks and preferred stocks

While common stocks and preferred stocks are both types of equities, there are some key differences between them. Preferred stocks usually have a fixed dividend rate, meaning that shareholders are guaranteed a specific amount of dividend payments.

On the other hand, common stock dividends are not fixed and can fluctuate based on the company's performance. Preferred stockholders have a higher claim on the company's assets and earnings in the event of bankruptcy than common stockholders.

Types of common stock

When it comes to common stocks, investors have a variety of options to choose from based on their goals and risk tolerance. Here are some common types of common stocks:

1. Growth Stocks: These stocks belong to companies that are expected to have above-average growth in earnings and revenues. They are often in high-growth industries like technology or healthcare. Growth stocks reinvest earnings back into the company to expand operations and capture market share. Investors are attracted to growth stocks for their potential long-term capital appreciation.
2. Value Stocks: These stocks are considered undervalued by the market. They trade at lower prices relative to their fundamentals like earnings, assets and cash flow. Value investors seek stocks they believe are trading below their true value. Value stocks often have stable businesses and may pay dividends. Investors in value stocks look for opportunities for price appreciation as the market recognises the stock's true worth.
3. Dividend Stocks: These stocks pay regular dividends to shareholders. They are typically associated with mature and stable companies that generate consistent cash flow. Dividend stocks provide investors with a steady income stream and are popular among income-focused investors, such as retirees. Dividends can be reinvested or received as cash payouts.
4. Blue-Chip Stocks: Blue-chip stocks are shares of large, well-established companies with a history of stable earnings, strong balance sheets and market dominance in their industries. They are considered safe investments with lower risk compared to smaller companies. Blue-chip stocks are known for their long track record of dividend payments and are favoured by conservative investors seeking stability and reliability.
5. Cyclical Stocks: These stocks are heavily influenced by the economic cycle. They perform well during economic expansion and underperform during downturns. Industries like automotive, construction and consumer discretionary have cyclical stocks. Investors in cyclical stocks need to time their investments based on economic indicators and market cycles.
6. Defensive Stocks: Defensive stocks tend to perform well even during economic downturns or market volatility. They belong to companies in industries relatively unaffected by economic fluctuations, such as utilities, healthcare, or consumer staples. Defensive stocks are considered stable investments that provide a level of protection during turbulent market conditions.

Examples of common stock

• Apple Inc (AAPL): Apple is a multinational technology company known for its consumer electronics, software and online services. It is one of the most valuable publicly traded companies in the world.
• Microsoft Corporation (MSFT): Microsoft is a technology company that develops, manufactures, licenses, supports and sells computer software, consumer electronics and personal computers. It is best known for its Windows operating system and Office suite of productivity software.
• ASML Holding NV (ASML): ASML is a Dutch multinational company that specialises in the development and manufacturing of photolithography systems used in the semiconductor industry. It is a key supplier to major semiconductor manufacturers worldwide.
• LVMH Moët Hennessy Louis Vuitton SE (MC): LVMH is a French multinational luxury goods conglomerate. It is known for its portfolio of prestigious brands in various sectors, including fashion, cosmetics, jewellery and spirits. Its brands include Louis Vuitton, Dior, Sephora and Moët & Chandon.
• Banco Santander, S.A. (SAN): Banco Santander is a Spanish multinational commercial bank. It offers a range of banking and financial services to individuals, businesses and institutions globally.

How to invest in common stocks

Investing in common stocks can be a rewarding way to grow your wealth. Here are some key considerations and strategies to consider if you are interested in investing in common stocks.

Consider market capitalisation

Stocks are classified based on market capitalisation (market-cap), which refers to the total value of a company's outstanding shares. The classifications include large-cap, mid-cap and small-cap stocks.

• Large-cap stocks: These stocks belong to well-established, stable companies with a market capitalisation typically exceeding $10 billion. Large-cap stocks are often considered less risky and may offer more stable returns.
• Mid-cap stocks: Mid-cap stocks represent companies with a market capitalisation ranging from $2 billion to $10 billion. These stocks can offer a balance between growth potential and stability.
• Small-cap stocks: Small-cap stocks belong to smaller companies with a market capitalisation below $2 billion. These stocks often belong to newer, growth-oriented firms and can be more volatile. They may provide opportunities for higher returns but come with higher risk.

Research and analysis

Before investing in common stocks, it can be crucial to research and analyse potential investments. Consider the following factors:

• Company fundamentals: Evaluate a company's financial health, including its revenue growth, earnings, debt levels and profitability.
• Industry analysis: Understand the industry trends, market dynamics and the company's position within its sector. Consider factors such as technological advancements, regulatory environment and competitive landscape.
• Management and leadership: Assess the company's management team, their track record and their ability to execute the company's strategy successfully.

Diversify your portfolio

Diversification can be essential to mitigate risk in your investment portfolio. Invest in a mix of companies, industries and market capitalisations. This helps spread your risk and potentially increases the likelihood of capturing positive returns.

Monitor and review

Regularly monitor your investments and stay updated on company and market news. Review your investment thesis periodically and adjust if necessary.

Pros and cons of investing in common stock

As with any investment, there are pros and cons to consider when investing in common stocks.

Pros of investing in common stock

• Potential for high returns: Common stocks have the potential to provide significant returns on investment. If the company performs well, the stock price can increase, leading to capital gains for the investor.
• Ownership and voting rights: As a shareholder, you may have a voice in company decisions.
• Dividend potential: Some companies pay regular dividends to their common stockholders.

Cons of investing in common stock

• Volatility: Common stocks can be subject to significant price fluctuations, which may result in losses.
• Lack of guarantees: There are no guarantees of dividend payments or capital appreciation.
• Risk of company bankruptcy: If a company goes bankrupt, common stockholders may lose their entire investment.