What is a Common Stock?

Common stocks are what typically come to mind when people think about stocks. They’re also the most typical kinds of investment vehicles that public companies issue. In the sometimes complicated jargon of investing, common stock is perhaps the most direct term.

So what is a common stock, and what role could it play in your portfolio? 

How Do Common Stocks Work?

Common stocks are far and away the most popular financial instruments for private investors. Publicly owned corporations have to raise capital for their projects. When they do, they release shares in the company for sale on the exchanges. These shares are common stocks.

Common stockholders become shareholders in the companies they invest in, which makes them part owners. Some investors hold on to these shares for a long time to promote stability. Others try to earn cash by selling when their shares hit a certain stock price target.

Advantages of Investing in Common Stocks

What is a common stock good for? Besides the easy transaction process, common stocks offer several benefits to stockholders. 

Earnings Potential

Accruing profit is why people get into the stock market. Common stocks generally have higher potential for strong returns than other securities. Some companies may offer periodic dividends for more revenue. 

Whether you prefer growth stocks that can make quick returns or buy-and-hold value stocks, common stocks can provide impressive incomes. 

Partial Ownership

Common shareholders have considerable influence over a company. Management listens to its shareholders because they’ve taken the investment leap, and shareholders are invited to periodic meetings. They have voting rights, giving them a voice in matters like stock splits, new share issuance, company direction and the board of directors.

Diversification and Flexibility

Spreading your investment capital across several companies and sectors helps control risk. If one sector’s having a rough go at the moment, another successful sector could compensate. Buying and investing in different common stocks or in an exchange-traded fund (ETF) can be the most hassle-free way to diversify your holdings.  

Inflation Hedges

Many perceive common stocks as protection against inflation. Investors expect to see their earnings increase alongside the stock price. Long-term capital appreciation also acts as a hedge against rising prices. 

Some companies additionally offer scheduled dividend payouts on earnings. If inflation has increased those earnings, investors could receive higher dividends. 

Risks and Considerations with Common Stocks

No investment strategy is immune to risk. Common stocks are no exception. The following are some factors to think about before investing.

Volatility and Risk

Even long-standing institutions experience times of peril. Common stocks are subject to wild price fluctuations and extreme market conditions. Those threats remain present even if the market’s been stable for a long time.

It’s vital to assess your aversion to risk. While it’s possible to make a quick profit off a growth stock, losing your investment is just as possible. Consider what balance of long- and short-term holdings you’re comfortable with. 

Money, Time and Work Commitment

If you’re managing your portfolio yourself, you might occasionally be strapped for resources. Conducting due diligence on potential common stocks can take up a lot of time, money and effort.

ETFs help take the time and work aspect out of everyday research.  Even with an ETF, investors need to do some research on them before buying.

Market Influences

Common stocks are vulnerable to external events in the stock market and the economy. Long-term recessions or booms have an effect. But there are more small-scale events that also impact a company’s balance sheet.

Changes in interest rates, technical outages, regulatory requirements, geopolitical differences and consumer sentiment can impact common stock investors. Worst-case scenarios are often devastating. Black swan events can be anything from a natural disaster or a pandemic to an explosive corporate scandal. 

Factors Affecting Common Stock Prices

Many variables come into play in the rise and fall of common stock prices. These are a few of the most important. 

Company Performance

Perhaps the most obvious factor behind common stock pricing is how well or poorly the company is faring. If the company is generating a lot of consistent income, its stock price is likely to be steady with long-term growth. If the company is struggling, its stock price can flatten or drop.

Market Conditions

Common stock prices are affected by the general shape of the stock market. Recessions make investors pull back, dropping share prices as a result. 

Economic booms promote higher trading volume, raising prices. And individual stock sectors — tech, media, consumer staples, energy and so forth — can experience their own boom-and-bust periods as well. 

Economic Indicators

Established measurements of the national and global economies also affect stock pricing. The gross domestic product (GDP) metric calculates the whole value of the goods and services within a given country. Unemployment, inflation and interest rates are considered as well.

In particular, the Consumer Confidence Index (CCI) is getting more attention these days, as is the Business Confidence Index (BCI). Confidence indexes, geopolitical policies, emerging markets, earnings report season and analyst reports have supporting roles in the pricing of common stock shares. 

Company News and Events

Individual companies are affected by news specific to them. After the late Steve Jobs first resigned from Apple, its shares lost around 5-7% of their value. When Satya Nadella took over as Microsoft’s CEO, its share price gradually increased. 

When energy company Enron became embroiled in a scandal of its own making, its share price tanked. Whenever a company makes the news or undergoes some kind of transformation, it can impact share prices. 

Supply and Demand Dynamics in Determining Stock Prices

Investor sentiment is a big impetus for stock price changes. If enough investors are enthusiastic about a certain company, the demand for its shares may exceed the supply. As a result, those share prices rise. But in bearish markets where investors can’t sell fast enough, the supply exceeds the demand. Share prices drop.

Strategies for Investing in Common Stocks

These strategies for investing in common stocks are some of the most prominent.

Value vs. Growth Investing

Blue-chip value stocks are giant commodities. Earnings are predictable and consistent, if not exciting. Growth stocks come from companies that are expected to take off in a big way — but they’re much riskier. Striking a balance is optimal.

Diversification

A diverse portfolio with holdings across different sectors can be a hedge against massive losses. When some sectors are in a downturn, other thriving sectors can make up the difference. ETFs are models of diversity that can spread your investments around.

Long-Term Investing

Buying and holding certain stocks for years — even decades — may result in steady capital appreciation and portfolio security. A bedrock of solid long-term stocks could ground your portfolio with a strong backbone.

Fundamental and Technical Analysis

Fundamental analysis helps investors arrive at a company’s worth. It includes studying prospects and management, a company’s financial results and industry trends. Technical analysis of stock prices is especially important for short positions, as they can indicate the best time to enter or exit. 

Time to Take Stock?

When you buy them with a carefully thought-out strategy in mind, common stocks can be dependable sources of security and income. There’s plenty of risk and uncertainty involved. However, a portfolio with strong common stock holdings can result in wealth.

Frequently Asked Questions