Classes of Capital Stock

Classes of Capital Stock
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Stocks are sometimes referred to as equities because they grant ownership within a company, according to FINRA. They’re subject to a number of rules and regulations, from the initial public offering, or “IPO,” to the ongoing rights that are granted to stockholders. Stocks are often held in stock funds, such as exchange-traded funds (ETFs) and mutual funds.

Capital stock falls into two classes. The two broad examples of capital stock are common stock and preferred stock.

Definition of Capital Stock

A company’s capital stock refers to the total number of shares of ownership or the amount of capital stock in a corporation. It can be traded on stock exchanges or transferred in private transactions. Investors can buy or sell publicly traded shares directly through their brokerage accounts or indirectly through mutual funds.

Corporations often issue a number of shares of capital stock to the public to raise funds. They must then follow regulatory guidelines on full and fair disclosure of information to the public.

Definition of Common Stock

Common stocks represent an issuance of equity ownership. Common stockholders typically vote in elections for company directors and approve corporate resolutions. They have limited liability, so creditors can’t pursue them for unpaid bills. Common stocks also usually rank last in terms of claims against a company's assets in bankruptcy cases, and they’re not automatically entitled to dividends.

A company may have different classes of common stock, such as Class A or Class B, with different voting rights. A Class A shareholder may have two or more times the voting rights of a Class B shareholder and may also have preference when dividends are announced. However, common stock is typically accepted to mean that only one class of stock is issued, according to Saylor Academy.

Common shares are generally the most liquid securities of a public company. Common stock appears as stockholders’ equity in the equity section of a company’s balance sheet.

Definition of Preferred Stock

Preferred stockholders have preference over common stockholders when it comes to dividends and priority, particularly in the case of bankruptcy. However, preferred stockholders generally do not have any voting rights. Preferred stocks allow companies to raise funds without going to the debt market and diluting the ownership of existing common stockholders.

The dividend rate is usually expressed as a dollar amount per share or as a percent of the par or face value of the preferred share. The annual dividend would be $6.25 ($100 x 0.0625) if a company issues 6.25 percent $100 par value preferred stock. Unpaid past dividends must be paid to preferred stockholders before common stockholders receive their dividend payments if a preferred stock is designated as cumulative.

A convertible preferred stock can be converted to common shares. A callable preferred stock can be redeemed by the company in exchange for cash. Companies can retain the right to buy outstanding shares back from their stockholders and convert them to “treasury shares.” This reduces the amount of shares available on the market.

How They Compare makes these major distinctions between common and preferred stock:

Preferred stockholders usually have priority over common stockholders. They'll be paid first if the company should experience severe economic hardship, restricting the payment of dividends. Their outstanding shares are paid first if a company experiences bankruptcy and its assets are subject to liquidation.

The Risks of Investing in Stocks

Two types of risks are associated with stocks: market risk and business risk. Market risk refers to the volatility of the stock markets. A stock’s value and market price may go down even if there’s been no change in the company fundamentals. Common stocks tend to be more volatile than preferred stocks.

Business risk means that a company's financial results may be affected due to changes in the economy, the competitive environment or customer preferences. Investors often diversify their stock holdings to reduce this type of risk.

Consideration: Par Value

Capital stock may have a stated par value. The par value for common stocks is usually a small arbitrary amount, and it’s not indicative of market value. The par value for preferred stocks has significance because the dividend payment is often stated as a percentage of the par value.