101-06 Types of Stock

Types of Stock

Common Stock

Common stock is the most commonly available type of stock.  This is what you would typically purchase when buying through brokers.  It represents a stake in the company.  If there are 10 million shares available for a company on the market and Bob purchased 1 million of them, this would necessarily give Bob a 10% stake in the business.  Along with purchasing common stock, you will get other benefits such as voting rights and the right to receive any paid dividends.  The voting rights will give you a vote in the election of the board of directors and corporate policy.

One of the negatives of owning common stock in comparison to being an owner of corporate bonds or a preferred stockholder is that you are further down in the pecking order to receive your investment back should the company go into liquidation.  In this instance, first, the bondholders and other loan providers are paid, then the preferred shareholders and then lastly the common stockholders.

The most significant benefit of being a common stockholder is that you will benefit the most from the growth in the share price.  Also, common stock is typically floated on a regulated exchange and therefore maintains a good level of liquidity.  Liquidity means that there are usually enough buyers and sellers at hand to ensure the stock is priced fairly.

Preferred Stock

Preferred stock is the type of stock that has more benefits in terms of claims on the underlying assets of the business in comparison with common stock.  It is essential to read the small print when buying preferred stock as the exact rights of preferred stock varies from company to company.  In general, the structure of the agreement will exclude voting rights and include a higher priority on dividend payments versus common stockholders.

One drawback apart from the lack of voting rights is that the preferred stock may not be available on the open market, meaning that it may not appreciate as much common stock and might not have the required amount of liquidity if you wish to sell.

Penny Stocks

Penny stocks are so-called because they tend to have a stock price below one dollar or even a stock price of a few cents.  While penny stocks may give the impression that they can double in value any minute and seem exciting to trade, the fact is they are penny stocks for a reason.

Reasons for stocks to be worth very little:

  • Weak products
  • Selling in a weak or shrinking market
  • They may be out of favor with investors or not be on the radar.
  • They could be heavily in debt
  • They have weak management

Stock prices are low because the company is not valued highly by the market.  So why would you buy them?  Also, many microcap (penny stocks) are not traded on the regular exchanges directly but in what is called the OTC (over the counter) or pink sheets market.  This means you might see wider spreads and a severely reduced liquidity.  Liquidity is everything when trading stocks because even if the price rises, you may not be able to sell the stock at the price you want because no one else is buying.  Also, even worse with low liquidity, if the stock is falling and you want to sell, there may be no buyers, and this can absolutely crush the value of the stock, causing you to wipe out entirely.

Many new “hot stocks” newsletters have sprung up over the years to break into this lucrative market; they offer their services for free.  “FREE STOCKS NEWSLETTERS.”  Just do not forget few things are “FREE” in this world, and the price you pay for these free newsletters is that the information will be biased against you.

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