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. 

Potential for High Returns

Investing in common stocks can lead to the possibility of substantial growth in value over time. Historically, stocks have shown better performance compared to other types of investments, like bonds or savings accounts, giving investors a chance to achieve higher returns.

Dividends

Companies often distribute dividends to their shareholders, creating an additional income stream alongside capital gains. Reinvesting these dividends can increase total returns due to compounding effects.

Ownership and Voting Rights

Buying common stocks lets investors own a portion of a company, which provides them with a share in its success. Common stockholders usually have voting rights on corporate issues, allowing them to affect company decisions.

Liquidity

Common stocks are usually bought and sold on large exchanges, which makes them fairly easy to trade. This allows investors to readily buy or sell shares, providing quick access to cash when necessary.

Diversification Opportunities

Investing in common stocks can help diversify an investment portfolio. By spreading funds across different industries and sectors, investors may lower risk and lessen the effects of assets that do not perform well.

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.

Market Volatility

Common stocks can experience changes in the financial markets, which may lead to notable price fluctuations. Factors such as the economy, investor sentiment, and geopolitical events can cause stock prices to increase or decrease significantly, potentially resulting in losses for investors.

Company-Specific Risks

Investing in individual stocks comes with unique risks related to the specific company, such as management choices, operational issues, or shifts in the industry. Factors like disappointing earnings reports, changes in leadership, or controversies can negatively impact a company's stock price.

Lack of Diversification

Putting a lot of money into a few common stocks can result in limited diversification. If those stocks don't do well, the investor could experience significant losses. A concentrated portfolio tends to be more susceptible to market declines than a diversified portfolio.

Long-Term Investment Horizon

Investing in common stocks can be risky for those looking for quick profits, as it may take some time for prices to bounce back after falling. Investors should adopt a long-term outlook and be ready to hold their stocks during market fluctuations to achieve potential returns.

Dividends and Payout Risks

Many common stocks offer dividends, but these payments are not assured. Companies can pause or lower dividends during economic challenges or financial difficulties, affecting income for investors who depend on dividends for consistent cash flow.

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