COMMON STOCKS: CHARACTERISTICS, TYPES, VALUATION, EXAMPLES - DUDAS - 2024

Common shares are a security that represents property in a corporation. Common stock holders exercise control by electing a board of directors and voting on corporate policy to follow.

It is the kind of action that most people think of when they use the term "actions." Common shareholders are at the bottom of the priority scale within the ownership structure.

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In the event of company liquidation, common shareholders have rights to the assets of a company only after the bondholders, preferred shareholders, and other debit holders receive their full payment.

Most of the time, shareholders receive one vote per common share. They also receive a copy of the corporate annual report. Many companies also give shareholders dividend payments. These dividend payments will vary depending on the profitability of the business.

The first common stock was established in 1602 by the Dutch East India Company and was listed on the Amsterdam Stock Exchange.

Actions in the company

In accounting, information about a company's common stock can be found on the balance sheet.

If a company does well or if its assets increase in value, common stocks can go up in value. On the other hand, if a company is doing poorly, a common stock can decrease its value.

characteristics

Common shares are bought and sold on a stock exchange. Because of this, the price of a common stock rises and falls according to demand.

You can earn money from common stocks in two ways: by receiving dividends, or by selling them when their price rises. The entire investment can also be lost if the share price collapses.

If a company goes bankrupt, common shareholders do not receive their money until creditors and preferred shareholders have received their respective share of the remaining assets.

The advantage of common stocks is that in the long run they are generally better than bonds and preferred stocks.

Initial public offering

Common shares are initially issued in an initial public offering. Prior to this, the company is private and financed through its earnings, bonds, and private equity investors.

To begin the initial public offering process, a company must work with an investment banking firm, which helps determine the price of the shares.

After completing the initial public offering phase, the public can purchase the new shares on the secondary market.

The company decides to go public for several reasons. First, you want to expand and you need the capital received in an initial public offering.

Second, the company offers stock options to incoming employees as an incentive to hire them.

Third, the founders want to capitalize on their years of work by winning large amounts of shares in an initial public offering.

Types

First order actions

Represents companies that have been uninterruptedly paying high dividends to their shareholders, for a long period of time.

Many stocks are highly rated, but they fail to have a track record of uninterrupted dividends.

All companies want to pay dividends to their shareholders. If a company has been paying dividends continuously, then it does not benefit it to stop paying dividends.

Income shares

The decision to pay dividends is made by the board of directors. The net profit after taxes, which is the final result of the company, should be distributed partly as a dividend and another part to be kept as retained profit.

Income shares are those that pay a higher-than-average percentage of net profit as a dividend.

Examples of revenue stocks are the telephone, electric and natural gas companies.

Defensive actions

They are enormously immune to fluctuations in the macroeconomy. They continuously sell their products on the market, regardless of the market's upward or downward trend.

Examples of defensive actions: retail foods, hardware, tobacco companies, and utilities. The market risk of these stocks is below average.

Cyclical stocks

Your luck is directly associated with the general condition of the economy. During the economic boom, the performance of these actions is effective. In the event of a recession, it performs poorly.

Examples are steel companies, automobile producers, and industrial chemical companies. The market risk of this stock is higher than average.

Growth Actions

They are companies that do not offer dividends to their shareholders and fully reinvest their income in new investment opportunities.

Investor perception is what makes growth stocks profitable.

Speculative stocks

They have the potential to pay their holders a large amount of money in a short period of time. The level of risk of these actions is very high.

Valuation

Dividend model

Calculate the intrinsic value of a company based on the dividends the company pays to its shareholders.

Dividends represent the actual cash flows the shareholder receives, so they should determine how much the shares are worth.

The first thing to check is whether the company actually pays dividends. However, it is not enough for the company to pay dividends. This must be stable and predictable. It is for mature companies in well-developed industries.

Cash flow model

Use the future cash flows of a business to value the business. The advantage of this model is that it can also be used in companies that do not pay dividends.

Cash flows are projected for five to ten years, and then a final value is calculated to account for all cash flows beyond the projected period.

The requirement to use this model is that the company has predictable cash flows, and that they are always positive.

Many high growth and immature companies will have to be excluded because of their large capital expenditures.

Comparable method

The method does not seek to find a specific value for the action. You simply compare the stock price indicators to a benchmark to determine whether the stock is undervalued or overvalued.

It can be used in all circumstances, due to the large number of indicators that can be applied, such as price to earnings (P / E), price to sales (P / V), price to cash flow (P / FE) and much others.

The P / G indicator is the one commonly used, because it focuses on the company's earnings, which is one of the main drivers of the value of an investment.

However, the company should generate positive profits. It would not make sense to compare with a negative P / G indicator.

Differences with preferred

The main difference between the two types of shares is that holders of common shares usually have voting privileges, while holders of preferred shares cannot.

Preferred shareholders have a greater claim to the assets and profits of a company. This is true when the company has excess cash and decides to distribute it in the form of dividends to its investors.

In this case, when making the distribution, it must be paid earlier to the preferred shareholders than to the common shareholders.

When there is insolvency, common shareholders are last in the company's asset line. This means that when the company must liquidate and pay all the creditors, the common shareholders will not receive any money until after paying the preferred shareholders.

Preferred shares can be converted to a fixed number of common shares, but common shares do not have this benefit.

Dividends

When you have a preferred stock, you receive fixed dividends at regular intervals.

This is not the case for common stocks, as the company's board of directors will decide whether or not to pay dividends. This is why preferred stocks are less volatile than common stocks.

Hybrid security

When interest rates go up, the value of preferred shares goes down, and vice versa. However, with common shares, the value of the shares is regulated by the supply and demand in the market.

Unlike common shares, preferred shares have a function that gives the issuer the right to redeem the shares from the market after a predetermined time.

Examples

Wells fargo

Wells Fargo has several bonds available on the secondary market. It also has preferred shares, such as its Series L (NYSE: WFC-L), and common shares (NYSE: WFC).

Alphabet

There are companies that have two classes of common shares: one with voting rights and one without voting rights. Alphabet (Google) is an example: Class A shares (symbol GOOGL) have voting rights, while Class C shares (GOOG) do not.

Common shareholders

Common shareholders have certain rights within the organization. They have the right to vote on business matters, as well as the members of the board according to their percentage of ownership.

This means that the 1% owner could cast a 1% vote at corporate meetings. Common shareholders also have the preferential right to maintain their percentage of ownership.

For example, if the company is trying to expand its operations by issuing more shares, the owner of the 1% has the right to purchase additional shares to maintain their 1% ownership before new investors can buy it.

One of the advantages of being a common shareholder is the right to receive dividends. This is not the right to declare the payment of dividends, but to receive them when they are declared.

When the board of directors declares dividends, common shareholders are entitled to receive a percentage of the dividends available for common shares.

References

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3. Wikipedia, the free encyclopedia (2018). Common stock. Taken from: en.wikipedia.org.
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5. CFI (2018). Common stock. Taken from: corporatefinanceinstitute.com.
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