Investing Essentials of Common Stocks

We have noted that a corporation is an artificial entity, created by law, and endowed with certain rights and privileges, among which is the right to issue shares of ownership called "common stock." The amount of stock authorized is stated in the corporate charter, and the amount to be issued and outstanding is determined by the board of directors.

Such shares o£ stock represent ownership of the total assets and are originally issued to persons who contributed their services and/or funds as part owners. However, these original owners may have found it desirable to sell all, or only part, of their holdings to others, who then, in turn, assume the status of owners, the transfer being easily effected on the books of the corporation. Such shares are termed common stock or capital stock, the former term being in most general use, and the total ownership is divided into a number of units called shares. A share of stock differs from a bond in the following ways:

(a) A bond is a contract and as such promises to pay a specific sum of money at a certain future time, and in the meantime to pay a specified rate of interest for the use of the borrowed funds; should the company be unable to meet its interest requirements, the bondholders may recover their funds through legal process.

In contrast, common stock has no maturity date and promises no fixed rate of return; furthermore, there is no recovery of the invested funds until the company is liquidated or perhaps merged with another. Risks are substantial and must be assumed, since the return upon the investment will depend upon the success of the company management. Obviously, a bondholder is in a favored position since he assumes a minimum of risk; on the other hand, the stockholder may obtain a handsome profit by assuming larger risks.

(b) Bondholders have no voice in management, while the stockholders, since they take all the risks, obtain the right to elect the directors and to vote upon matters of company policy.

(c) In the case of bankruptcy, reorganization, merger, or any other change in company status, the bondholders and/or preferred stockholders receive preferential treatment, while the stockholders receive last consideration; the advantages of a simple capitalization, involving common stock alone, are evident.