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Common Stock
The ownership of a corporation is divided into transferable units known
as shares of stock. There are several categories, or classes, of
stock. Individuals and companies buy stocks because they expect to
profit when the corporation makes profits. Corporations issue two
basic types of stock: common stock and preferred stock.
Corporations differ from other types of business structures, such as sole
proprietorships and partnerships. In sole proprietorships, one person
(the owner) receives the profits. In partnerships, only the partners
share in any financial gains. But in a corporation, hundreds,
thousands, and sometimes even millions, of stockholders share the profits.
Furthermore, in the corporate structure, stockholders may buy and sell
ownership (company stock) without interfering with the activities of the
corporation. There are millions of transactions that occur daily on
stock exchanges, and they are independent transactions between buyers and
sellers that do not affect the daily operations of the corporations
involved. This is in contrast to sole proprietorships and
partnerships, where the life of the business ceases when ownership changes.
One other important distinction between a corporation and the other types
of business structures is investors (stockholders) in a corporation limit
their losses to the amount that they invest in shares of stock, if the
company would get into serious financial difficulties.
The most popular investment vehicle in the stock market is common stock.
One share of common stock represents one-part ownership in a corporation.
If you owned 1,000 common shares of ABC Corporation, and they have 100,000
shares outstanding (sold), then you would own 1% of the ABC Corporation.
As a shareholder (owner), you have the right to vote on important corporate
issues, such as the election of a corporation's board of directors, and
mergers or acquisitions (the joining with, or the taking over of, another
company).
There are two basic ways that an investor can make money by buying common
stock. The first way is that the stock could increase in market value.
The stock price will increase in market value when buyers bid the stock
price up when trying to acquire shares of the stock. You, no doubt,
have seen this happen with other consumer products. When the
PlayStation 2 Video Game System first came out, everybody wanted one, but
there were not enough systems available; thus, people were willing to pay
more than the suggested retail price in order to acquire the system.
While game players were trying to acquire the system, investors were trying
to acquire Sony (the manufacturer) stock. Those investors who
currently held Sony stock could sell to those trying to acquire the stock at
a price higher than the price they originally paid for the stock, thus
making a profit.
The second way of making money via common stock is through the
corporation's dividend policy. A dividend is money given to each
shareholder as a way of sharing the corporate profits with the owners or
stockholders. Typically, the more profit a corporation makes,
the more dividends the stockholders make.
It should be noted at this point that making money by investing in common
stock is not guaranteed. The market price of the stock could drop in
value if the company is mismanaged or if the company does not live up to
investors' expectations. Furthermore, dividends are not guaranteed
either. Looking at a company's past dividend record gives you a pretty
good idea of how much in the way of dividends per share they are likely to
pay in the future, but the corporation is under no legal obligation to pay
dividends.
A distinctive feature of corporations is that they have shares of stock,
and they can distribute profits to the shareholders via dividends. The
dividends that are paid to shareholders represent a positive return on
investment (profit) for the firm and can be directly distributed to the
shareholders. As mentioned above, the payment of dividends is at the
discretion (option) of the board of directors. Some important
characteristics of dividends include the following:
- Unless the board of directors of the corporation declares a dividend,
it is not a liability of the corporation. A corporation cannot
default on an undeclared dividend. As a consequence, corporations
cannot become bankrupt because of nonpayment of an undeclared dividend.
- The payment of dividends by the corporation is not a business expense.
Dividends are not tax deductible for corporations.
- Dividends received by individual shareholders are, for the most part,
considered ordinary income by the IRS, and are fully taxable.
Preferred Stock
Preferred stock has attained this name because it receives preferential
treatment when it comes to the payment of dividends. Not all companies
have preferred stock. But for those that do, they need to pay a
predetermined, stated amount of dividend to the preferred shareholders
before they can distribute any dividends to common shareholders.
Dividend payments are not legally required; thus, if the company does not
have excess profits, it might very well forgo paying dividends that year.
This leads us to the different types of preferred stock. The two major
classes of preferred stock are non-cumulative and cumulative.
Non-cumulative preferred stock requires the corporation to first pay
dividends to the preferred shareholder, up to the predetermined, stated
amount, before paying any dividend to the common shareholders. If no
dividends are declared or distributed, then the slate is clean, and the
corporation does not have to make up any past dividends that were not
previously paid.
Cumulative preferred stock also requires the corporation to pay preferred
shareholders before common shareholders. But with cumulative preferred
stock, any unpaid past dividends must be brought up-to-date before any
dividends can be paid to common stock shareholders. It might seem like
purchasing preferred stock makes a lot more sense than purchasing common
stock, because preferred shareholders always get paid first. While
preferred shareholders do get paid first, they only get the predetermined,
stated amount of dividend and never any more than that. Thus, if the
company is doing very well, then the common shareholders are likely to
receive much larger dividends than preferred shareholders. Usually,
the preferred stock dividend is much smaller than common stock dividends,
and the market price of preferred stock is much more stable than common
stock. your risk tolerance (how much you're willing to lose compared
to how much you would like to gain) will be a big factor in choosing the
type of stock you purchase. Preferred stock also differs from common stock
in that it usually does not have voting rights on important corporate
matters, as does common stock. Activity
Complete the worksheet
Group Activity With your stock market group,
pick 5 MAJOR companies. Research the following for each company...
- About the company (What do they do? What exchange are they on?
What is their stock symbol?)
- History of the company
- Management
- Sales pie chart
- Graph of stock performance for 1 year
See the following website for examples...
http://library.thinkquest.org/3088/?tqskip1=1&tqtime=0302
Click on Company Profiles
Organize this information into a PowerPoint Presentation.
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