Capital stock refers to the shares of a corporation, which 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 shares to the public to raise funds, and they then must follow regulatory guidelines on full and fair disclosure of information to the public. The two broad classes of capital stock are common and preferred.
Common stocks represent equity ownership. Common stockholders typically vote in elections for company directors and approve corporate resolutions. They have limited liability, meaning creditors cannot pursue them for unpaid bills, but they also usually rank last in terms of claims against a company's assets in bankruptcy cases. They are 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. For example, a Class A shareholder may have two or more times the voting rights of a Class B shareholder and also may have preference when dividends are announced. Common shares are generally the most liquid securities of a public company.
Preferred stockholders have preference over common stockholders when it comes to dividends and priority in the case of bankruptcy. 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. For example, if a company issues 6.25 percent $100 par value preferred stock, then the annual dividend is $6.25 ($100 x 0.0625). If a preferred stock is designated as cumulative, then unpaid past dividends must be paid to preferred stockholders before common stockholders receive their dividend payments. A convertible preferred stock may be converted to common shares. A callable preferred stock can be redeemed by the company in exchange for cash. Preferred stockholders generally do not have any voting rights.
There are two types of risks associated with stocks: market risk and business risk. Market risk refers to the volatility of the stock markets, meaning a stock’s value may go down even if there has 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 risk.
Consideration: Par Value
Capital stock may have a stated par value. For common stocks, the par value is usually a small arbitrary amount and not indicative of market value. For preferred stocks, the par value has significance because the dividend payment often is stated as a percentage of the par value.
Based in Ottawa, Canada, Chirantan Basu has been writing since 1995. His work has appeared in various publications and he has performed financial editing at a Wall Street firm. Basu holds a Bachelor of Engineering from Memorial University of Newfoundland, a Master of Business Administration from the University of Ottawa and holds the Canadian Investment Manager designation from the Canadian Securities Institute.