A little history lesson: In the Middle Ages, European and Chinese merchants separately came up with the idea of the joint stock company to formalize shared ownership of profit-seeking enterprises among multiple individuals or families. By broadening the ownership base — through a system of common and preferred shares — companies could raise more capital and grow larger than was previously possible with sole proprietorships.
That’s essentially the same system today.
Today’s common share owners make money in two ways: through capital gains, which is the growth in price from the day you buy to the day you sell, and via dividend payments, which is money paid out of profits to shareholders. (Of course, share values can also fall to zero should the company go bankrupt.) How much you make depends on how many shares you own.
Let’s take a deeper look at how common shares work, and the pros and cons to share ownership.
What are common shares?
Common (also called ordinary) shares are a type of security that give investors partial ownership of a company. By acquiring common shares, investors are granted the right to vote on key aspects of the business and participate in any ongoing and future profits.
These shares, which are generally used by businesses to raise capital, can be bought and sold on exchanges, such as the TSX or the NYSE. Common shares might also reward investors with dividends. Stocks can be riskier than other investments, such as government bonds, which guarantee investors the return of their principal plus interest, or Guaranteed Investment Certificates, which also pay interest and protect 100% of your principal. But with this added risk comes the potential for greater rewards as long as the business succeeds.
Why do people buy common stock?
Common stock offers investors a way to share in the profits of a successful business. If the value of a company’s shares increases after you buy them, you can sell them for a profit (or a capital gain). By holding common shares, you also get a say in the direction of a company by voting on matters that can have a direct impact on the company, including its leadership, executive compensation and acquisitions. The more shares you own, the bigger say you have.
How much can you make in a year if you buy $1,000 of common shares?
There is a range of variables that will affect what the $1,000 you invest at the beginning of a year will be worth by the time the winter holidays roll around. The most obvious is how the company performs. Technically, there is no limit to how much you can make in a year on your investment — and the share price isn’t the only factor. The dividends a company might pay to its shareholders can also boost your total annual return. Of course, you can also lose money or potentially all of your investment if the business falters. That’s the worst-case scenario.
Real world examples
The volatility that makes common shares risky can also be what rewards savvy investors who hang on to their investments over the long term. As famed U.S. investor Warren Buffett once said, “If you aren’t willing to hold a stock for 10 years, don’t even think about holding it for 10 minutes.”1 That’s because even though stocks may fluctuate over the short term, the market itself generally rises over time. In his annual letter to Berkshire Hathaway investors, Buffett explained that his “secret sauce” to investing involves identifying companies with “long-lasting favourable economic characteristics and trustworthy managers.”2 Some investors choose to seize on market volatility to add to their positions (here are some of the things you can do when markets tumble). Volatility aside, if you don’t understand a business or the people running it, you may want to consider carefully before risking your money.
How do common shares work?
How to calculate the value of a common share?
It’s useful to know how many common shares a company has outstanding. That’s because the value of each share — and the percentage of ownership it represents — can fluctuate over time. If new shares are created and issued too quickly, a company risks diluting ownership and lowering the value of its shares. The simplest way to arrive at the number of outstanding shares is to take the total number of shares a company has issued and subtract its treasury stock (or the number of shares it has bought back).
How do you read common stock on a balance sheet?
If you want to find out the number of common shares held by investors, you can find that information on the company’s balance sheet. It’s an important figure that will help you calculate the book value of a company — or what the business is worth according to its financial statements — which can help you assess if the shares are fairly priced on the market. Companies that are experiencing rapid growth may be trading for much more on the stock market than their book value would suggest. Likewise, the shares of struggling companies may come at a discount compared to their book value.
Advantages of common shares
Ownership of a corporation
Common shares give investors partial ownership of a company. The more shares you own, the greater your stake in the business and the more you stand to profit should the value of these shares increase.
Voting rights
One of the perks of common shares is that they allow you to vote on important matters that shape how a company performs. The more shares you own, the greater the say you have. As an investor, the issues you are allowed to vote on can vary significantly from company to company but generally include the election of the board of directors and any proposed structural changes to the company. Common shareholders also have a say on issues that pertain to stock ownership, such as mergers and acquisitions or stock splits.
Dividends
In addition to capital gains, common shareholders can also benefit from dividends, which is the distribution of a company’s profits to investors. Although dividend yields can vary, these payments are generally made quarterly in the form of cash or additional shares in the company. The capital gains an investor makes on their shares combined with any dividend payments they receive is referred to as an investment’s total return. These small payments can make a big difference on your investment over time, which is one reason why dividend reinvestment plans are so popular.
Disadvantages of common shares
They can be risky
Common shares are volatile because they are tied to the performance of a company. If that company underperforms, the value of these shares can decline to the point of being worthless.
Shareholders get paid last
If a company is forced to enter bankruptcy proceedings, creditors and preferred shareholders are prioritized ahead of common shareholders when it comes to bankruptcy payouts. That’s because creditors and preferred shareholders are considered lenders; they get paid before owners — which is what shareholders are.
What are preferred shares?
Preferred shares, the other main type of stock used by companies in search of capital, also grant investors partial ownership of a business but they do not include voting rights. These shares get the “preferred” label because they usually pay out dividends on a regular schedule — and before any such payments are made to the owners of common shares. Preferred shares are considered less risky than common shares, but they do not carry the same potential for capital gains.
Common shares vs. preferred shares
Both types of stock grant investors partial ownership in a company but common shares are more widely available. Common shares also come with voting rights and generally have more long-term growth potential. Common shares are also riskier, and, if a company fails, preferred shareholders get paid out first.
How to buy common shares?
Common shares can be purchased by opening an account with an online trading platform. TD Bank offers TD Direct Investing and TD Easy Trade — two options that can help you get started.
FAQ: Common shares
What is common stock in simple terms?
Common stock is a type of security that gives investors partial ownership in a company and the right to vote on important matters involving that company’s business.
How are common shareholders paid?
Common shareholders make money in two ways: through capital gains and dividends. The former occurs when common shareholders sell their shares for more money than they paid for them. The latter happens when a company shares its profits with investors in the form of a cash or stock dividend.
Is a common share an asset or an expense?
Common shares are assets that have value and can be sold for cash.
How are common shares taxed in Canada?
Common shares held outside of a registered account, such as a Registered Retirement Savings Plan or Tax-Free Savings Account, are subject to capital gains tax. In these cases, half the profit, or capital gain, is subject to be taxed at your marginal tax rate. For instance, if you made $1,000 from the sale of stock, you’d get taxed on $500.
What is a capital loss?
Occasionally you may end up selling an investment for a loss. If that happens outside of a registered or tax-advantaged account, you can claim that loss on your taxes to offset any capital gains you’ve earned in other parts of your portfolio.
What is the difference between common stock and common shares?
There is no difference between these two terms — the terms are interchangeable.
Is common stock an equity?
Yes, common stock is a form of equity. It is recorded in the stockholders’ equity section of a company’s balance sheet.