Stock Market Basics - Common Stock vs Preferred Stock

Types of stock – common vs. preferred

The type of stock most commonly that you will see in the market is the normal stock or which is known as common stock. In fact most of the companies issue that stock only.

You would wonder why the common stock is different than the other stock known as preferred stock and why the companies issue them. As a stock market basics student you should know the difference if you want to buy the correct type of stock and earn money.

What is different is the way the voting rights are issued to people and also that drives how the preferred stocks have less risk than the others. Let us say the company wants to have the voting rights restricted to a certain set of people but also wants the general public to invest in stock but does not want to give them much voting power.

Now this voting power is generally needed to get resolutions and agreements done at the Annual general body meeting or the extraordinary general body meeting. Suppose hypothetically if the entire general public ganged up against the company then you can always have the resolutions blocked and the may be have some things be approved with the people managing the company having no say in the decisions.

To avoid these kinds of situations it is required sometimes by the company to offer preference shares to certain investors who are more than likely to side by the management. These preference shares usually will carry more voting power than the general class of shares. For example preferred shares will have ten voting rights per share as opposed to common shares which will have only one vote per share.

The preference shares have a fixed dividend and they are assumed to be like a hybrid between shares and bonds. Also in the event of liquidation these stock are known to be very much like the common stock apart from the fact they will come in first to get any assets upon liquidation and then will come the common stock holders.

Classes of Stock

Several companies also offer different classes of stock which may be helpful for the voting rights differentiation as well. If you are reading a stock market ticker you would notice the class right next to the stock symbol e.g share XYZ will be marked as XYZa and XYZb or XYZ.a and XYZ.b

Hope you enjoyed this stock market basics lesson about classes of shares.

Stock Market Basics - Risk vs Return

As your learn the stock market basics you will need to make sure your understand the basics of what is Risk vs Return theory.

The risk of owning a stock which may or may not do well can be quite a handful. However if you play your cards well the returns will be greater. Let me give you an example in the case of the bonds let us say a company will say they will pay oout 7% interest on the bonds. That means you are now bound to earn 7% annualy on your investment whatever may be the state of the economy or the company.

However let us say if you buy a stock which does not give out any dividends but you still go ahead and buy the stocks. This stock will be with you let us say for a few years. These years may see the economy in general go up and then down. But the fact is that the stocks can average 10-12% over a period of few years. Yes, that is correct but in may so happen that the company goes bankrupt or goes into serious problems and not able to recover such that you will ultimately have to sell at a loss or hold the shares in the hope of the rebound of the company's fortune. What that menas that you carry the risk of the losses and it may so happen that you lose all your money however you will make much more money in case of the company doing well.

As a stock market basic rule the higher the risk higher the return but in turn the higher return may not always be true but also can be likely high losses.

The trade off of risk vs return is everywhere and as they say stock market is not for the faint hearted . You should have appetite for risk and stomach for riding over the losses for longer periods of time till the tide turns and you rake in huge abnormal profits.

That means what is the time horizon for your investment and for a short term player the appetite for risk should be larger than the appetite for risk for long term players. I will detail in another session of the stock market basics what is short term versus long term investments.

Stock Market Basics - Debt Vs. Equity

As a stock market basics student what you need to understand is how the stock is issued and what impact does it have on the company in terms of its shareholding as well as what happens when the company takes on more debt than it is supposed and also how the stock market looks upon the debt vs equity.

As a company owner you can do two things either borrow from somebody or borrow from the public and make them part owners of the company.

When the company takes on loan from the bank or issues bonds it is known as debt financing. As a debt financing strategy you do not want have more debt o your books that means that you need to have more progits to repay that debt.
When you buy the bonds of the company you are assured that the company will pay you a certain amount of interest every year and at the at end of the specified year the original or the principal amount will be paid back to you.

On the other hand when a person takes a loan and does not return that then it is a case of bad credit personal loans.

The other case is equity financing where the company offers the stock to several investors including public and it is known as initial public offering. In this the investors buy the stock in the hope that the company will do well and they will some day part with the stock at a value more than what they bought it for. The company benefits as they do not have to repay anything as well they have absolutely nothing to pay in terms of interest payments . This is what really the stock market basics is for you in terms why people issue stocks and are willing to part ownership of the company.

They can pay the investors some part of the profit called dividends but that is not mandatory. in fact a lot of companies do not even issue dividends for most of the formative years of the company. In the cae of equity you are not assured anything and there is absolutely no guarantee that you will get your money back in case the company does not do well or even when the company goes bankrupt . In case of the liquidation of the company the first right is of the debtors and the next right is of the preference share holders and then come the shareholders.

Let me reiterate this importnat fact of stock market basics, which tell you that you make money from the stock market only if the company does well and you are willing to take risk.