Common Stock
Common stock represents ownership (equity) in a corporation. As partial owners, common stockholders have specific rights and are entitled to participate in the company's success—but they also bear the greatest risk if the company fails.
Characteristics of Common Stock
Common stock is the most basic form of corporate ownership. When you buy shares of common stock, you become a part-owner of the company with several important rights.
Ownership Rights
| Right | Description |
|---|---|
| Voting Rights | Vote on directors, major corporate decisions, stock splits |
| Dividend Rights | Receive dividends if declared (not guaranteed) |
| Residual Claim | Entitled to assets after all debts paid in liquidation |
| Preemptive Rights | May have right to maintain proportional ownership |
| Transferability | Can freely buy and sell shares on open market |
| Limited Liability | Maximum loss is limited to amount invested |
In Practice
When Apple holds its annual shareholder meeting, every common stockholder has the right to vote on matters like electing board members, approving executive compensation plans, and ratifying the selection of auditors. Shareholders who cannot attend in person can vote by proxy.
Types of Voting
There are two primary methods of shareholder voting, and the distinction matters significantly for minority shareholders.
Statutory Voting
In statutory voting (also called regular or straight voting), shareholders receive one vote per share for each position being filled. Votes must be cast separately for each director position.
Example: If you own 100 shares and there are 5 director positions:
- You have 100 votes for Position 1
- You have 100 votes for Position 2
- And so on...
- You cannot combine votes across positions
Cumulative Voting
In cumulative voting, shareholders can concentrate their votes on fewer candidates. This method benefits minority shareholders by giving them a better chance of electing at least one director.
Formula: Total Votes = Shares Owned × Number of Positions
Example: If you own 100 shares and there are 5 director positions:
- Total votes = 100 × 5 = 500 votes
- You can allocate all 500 votes to one candidate
- Or split them any way you choose among candidates
On the Exam
Cumulative voting questions typically ask which voting method benefits minority shareholders. Remember: Cumulative voting allows vote concentration, giving minority shareholders more power to elect at least one sympathetic director.
Preemptive Rights
Preemptive rights give existing shareholders the first opportunity to purchase new shares before they are offered to the public. This protects shareholders from dilution of their ownership percentage.
How Preemptive Rights Work
When a company issues additional shares, existing shareholders with preemptive rights receive subscription rights to buy new shares in proportion to their current ownership.
Example:
- You own 1,000 shares (10% of 10,000 outstanding shares)
- Company issues 2,000 new shares
- With preemptive rights, you can buy 200 shares (10% of 2,000)
- This maintains your 10% ownership stake
Important Points
- Not all companies grant preemptive rights—check the corporate charter
- Rights are typically exercised at a discount to market price
- Rights have a short expiration period (usually 30-45 days)
- Rights can be sold if shareholder doesn't want to exercise them
- Preferred stockholders generally do NOT have preemptive rights
Stock Value Concepts
Understanding different measures of stock value is essential for investment analysis.
| Value Type | Definition | Significance |
|---|---|---|
| Par Value | Arbitrary value assigned at issuance | Usually $0.01-$1; no economic significance |
| Book Value | (Assets - Liabilities) ÷ Shares Outstanding | Accounting value; may differ from market |
| Market Value | Current trading price | What investors are willing to pay |
| Intrinsic Value | Estimated true worth | Based on fundamental analysis |
Book Value Per Share
Book Value = (Total Assets - Total Liabilities - Preferred Stock) ÷ Common Shares Outstanding
Book value represents the accounting or "liquidation" value of common equity. If book value significantly exceeds market value, the stock may be undervalued (or the company may have problems not reflected in book value).
Stock Splits and Stock Dividends
Forward Stock Splits
A forward split increases the number of shares while proportionally reducing the price per share. Total value remains unchanged.
| Split Ratio | Shares Before | Shares After | Price Before | Price After |
|---|---|---|---|---|
| 2-for-1 | 100 | 200 | $100 | $50 |
| 3-for-1 | 100 | 300 | $90 | $30 |
| 3-for-2 | 100 | 150 | $60 | $40 |
Why companies split stock: To lower share price and improve liquidity, making shares more accessible to small investors.
Reverse Stock Splits
A reverse split reduces the number of shares while proportionally increasing the price per share.
Example: 1-for-5 reverse split
- Before: 500 shares at $2 = $1,000
- After: 100 shares at $10 = $1,000
Why companies reverse split: To increase share price, often to maintain listing requirements (many exchanges require minimum prices).
Stock Dividends
A stock dividend distributes additional shares to existing shareholders rather than cash. Like splits, total value is unchanged—you just own more shares at a lower price per share.
Cash Dividend Dates
Understanding the four key dividend dates is crucial for the exam.
| Date | Description | Key Point |
|---|---|---|
| Declaration Date | Board announces dividend | Creates legal obligation |
| Ex-Dividend Date | First day stock trades WITHOUT dividend | Set 1 business day before record date |
| Record Date | Date of shareholder registry check | Must be owner of record to receive dividend |
| Payment Date | Dividend is distributed | Cash or shares delivered |
The Ex-Dividend Date Rule
As of May 2024, stock trades settle T+1 (one business day after trade). Therefore, the ex-dividend date is now one business day before the record date.
- Buy BEFORE the ex-date: You receive the dividend
- Buy ON or AFTER the ex-date: You do NOT receive the dividend
In Practice
If a stock has a record date of Thursday, December 5th:
- Ex-dividend date = Wednesday, December 4th
- Buy on Tuesday, December 3rd → You GET the dividend
- Buy on Wednesday, December 4th → You do NOT get the dividend
The stock price typically drops by approximately the dividend amount on the ex-dividend date.
Key Takeaways
- Common stockholders are owners with voting rights but are last in line in liquidation
- Cumulative voting benefits minority shareholders by allowing vote concentration
- Preemptive rights protect against dilution of ownership percentage
- Stock splits and stock dividends change share count and price but not total value
- Must buy before the ex-dividend date to receive the declared dividend
- T+1 settlement means ex-date is 1 business day before record date
Cumulative voting most benefits:
In a 3-for-1 stock split, an investor holding 100 shares at $60 per share would have:
An investor purchases stock on Wednesday. The ex-dividend date is Thursday. Will the investor receive the upcoming dividend?
5.2 Preferred Stock
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