Stocks are securities that represent a % of ownership of a corporation. This entitles the owner (stockholder or shareholder) a fraction of the firm’s profits. Understanding stocks is a very important element as for us individuals; we get to make money through investment and as for corporations; they get to equity finance. Stocks are a way in which ordinary people like you and me; can invest in successful companies all over the globe. Allowing us to receive a % on the profits. The units of stocks are known as shares, thus calling a stock owner a shareholder. As we go further, we’ll see the types of stocks and their differences.
Types of stocks
When a common man discuses stocks, he/she is talking about this type. Most of the stocks issued are common stocks. Like we talked about stocks previously; the stockholder has the % of ownership right over the company as well as the claims(dividends). However, variable returns are to be received which are never guaranteed due to the extreme risk involved. The investors have the right of one vote per share when elections take place for the BOD (board of directors); while most of the decision making is done by the management. In the long run, common stocks do give out higher returns; but it surely comes with a higher risk. Common stocks have a very high risk as if a company goes penniless; the shareholders will not be repaid the initially invested amount till creditors, preferred shareholders, and bondholders are paid off.
The preferred shareholders tend to receive the extent of ownership of a company; however, they do not have any voting rights (unless exception made by a firm). The word preferred comes from preference; and these types of shareholders do get the preference to receive a fixed amount of dividend; making it secure for them to an extent. A pro to this type of stock is that in case of liquidity, the preferred stockholders will be paid off before the common stockholders (still after the debt holders). Preferred stock is more of a midway of common stocks and bonds.
These two stocks are surely the main types however firms do alter sometimes when it comes to equity. Thus, coming up with different classes of shares which depict their characteristics. Showing us how understanding stocks and its further types is really important. The main reason for doing this is; to take control of voting and keep it within a range of a specific group.
The common stock rule- One vote per share
Like the preferred stockholders- The shareholders have no voting rights
Mainly held by the founders of the firm- 10 votes per share (No public trading of Class C shares)
Stocks tend to have different market and intrinsic values due to certain factors; while the equilibrium point can be attained as well as summarized below-
You may ask:
Why do firms and investors care about the intrinsic value?
And the answer would be: The investors’ goal is to purchase undervalued stocks and avoid any overvalued ones. Thus making it evident that while we go through the process of understanding stocks; its valuation holds great importance. Eventually making the intrinsic value a significant factor while the decision-making takes place when issuing shares.
Taking about valuing shares; stock valuation takes place like the way other financial assets are valued. Mainly as the present worth of its expected future cash flow stream.
The expected future cash flows primarily comprise of two elements:
1. Dividend expected each year
2. The expected price investors will receive when the stock is sold
With the help of a series of formulas used along with financial calculators; the future cash flows are calculated, and decisions are taken according to the expected values
Giving you an insight into what stocks are and helping you easily understanding stocks; we hope that the importance of this topic is well understood by you. No legal firm operates without shareholders and so the importance is obviously in front of us. This intro may lead you to further deep learning so you may check out some intense work here to learn more.