Common Stock: Meaning, Types & Common Mistakes

Common stock represents ownership in a company and gives shareholders the right to vote on corporate decisions and receive dividends. It is the most widely issued form of equity, reflecting the residual claim of investors after all obligations are met.

Common stockholders are the last to be paid in case of liquidation but enjoy the potential for higher returns when the company performs well.

Common stock is a type of security that signifies ownership in a corporation. Each share entitles the holder to voting rights and a proportionate claim on profits through dividends.

Companies issue common stock to raise capital for expansion, acquisitions, or debt repayment. Investors holding common stock benefit from capital appreciation and dividend income, though both are subject to market performance.

In simple terms, it represents a stake in the company’s future earnings and growth.

Before investing, it’s important to understand what distinguishes common stock from other financial instruments.

Here are the main features:

• Ownership Rights: Common stockholders are partial owners of the company.
  

• Voting Power: They can vote in board elections and on major policy decisions.
  

• Dividend Entitlement: They receive dividends, though the amount varies based on profits and company policy.
  

• Residual Claim: In case of liquidation, they are paid after bondholders and preferred shareholders.
  

• Transferability: Shares can be freely traded in secondary markets like stock exchanges.
  

• Capital Appreciation: The potential for stock price growth makes it attractive to long-term investors.

The value of common stock can be estimated using the Dividend Discount Model (DDM), which projects the present value of future dividends.

Formula:

• Value of Common Stock (P₀) = D₁ ÷ (r – g)

Where:

• D₁ = Expected dividend next year
  

• r = Required rate of return
  

• g = Dividend growth rate

Example:
If a company expects to pay ₹10 per share next year, dividends are projected to grow by 5%, and the required rate of return is 12%, then:

P₀ = 10 ÷ (0.12 – 0.05) = ₹142.85 per share

This model is most effective for mature, dividend-paying firms.

Suppose an investor buys 1,000 shares of a company at ₹150 per share, and after a year, the price rises to ₹180, with a ₹5 dividend paid.

The total return is:
= ₹(180 – 150) + ₹5 = ₹35 per share
= ₹35 ÷ ₹150 × 100 = 23.3% annual return

This shows how common stock rewards investors through both price appreciation and dividend income.

Common stock is the foundation of corporate ownership and an important component of wealth creation in equity markets. It offers investors a chance to participate in business growth and profit distribution while assuming higher risk.

Successful equity investing lies in choosing fundamentally strong companies, managing risk, and maintaining a long-term perspective.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.