In our previous instalment, we looked at what a stock market or stock exchange is and its role in the world of investments. “The entire purpose of the stock exchange is to facilitate the exchange of shares from the seller to the buyer at a price that is agreeable.” We will now move forward and look at one product that is available to you on the stock exchange-common shares.
COMMON SHARES
Common shares are the fundamental investing tool used by individuals, institutions and investment funds to create savings, growth and income in most economies around the world. A common share is evidence of a person’s ownership in a company. The holders of common shares have several “rights” because of this ownership position, which we will explore. Let’s begin by dismissing one very glaring exception to your “rights.” As a public shareholder, you do not have the right to walk into our company, Orange, and talk to the manufacturing manager and tell him to change the colour of our widgets. Common shareholders may be owners, but they do not have day-to-day management rights or obligations. However, you do have some very important rights.
As a share owner, you may attend the annual general meeting where you may ask questions of management and the board of directors. You can vote on any motions put forward, including the election of directors. You may also put your name forward to become a member of the board. You will be eligible to receive any profits that the board may decide to share with stockholders. They call these “dividends,” and may be a very important reason to become a shareholder. Dividends can provide an excellent source of income from your investing efforts.
Let’s come back to a real life example of something else connected with holding common shares in a company. Suppose, for a moment, that Orange was not a public company, and you were its founder. You start in your garage, begin building and selling widgets, and something goes wrong. Let’s suppose that some technological innovation renders your widget obsolete. In the meantime, you have been buying raw materials, paying for employees, marketing, shipping, etc. But it all crashes to a close. You have outstanding obligations to suppliers, employees, banks and much more. As the sole owner, you are on the hook for any outstanding obligations.
The question then becomes, as a common shareholder, what obligations do you have in the event the company goes under? The answer is none. You may lose your investment in purchasing the shares, but that is the limit of your losses. Creditors cannot request compensation from you. Some of you smart business people may say, “But if you incorporate your business, they also cannot hold you responsible.” Strictly speaking, that may be true, but practically, the chances of a small, new business getting any kind of credit from banks or suppliers will depend on the owner giving a personal guarantee.
As a common stockholder, it entitles you to your share of any assets left over from the winding up of the business. They would provide this after it pays other debts, and the organization fulfils certain other financial responsibilities. We refer to common stock as “equity” in the company, reflecting your position as an owner. Analysts often use the equity on a balance sheet as a reflection of the company’s financial health. Besides cash flow, there are two other ways of raising money in a company, offering equity or shares and incurring debt. As a shareholder, you are an equity holder.
As previously mentioned, we are not going into great depth about the accounting ramifications and how common stock and equity are involved-this is a simplified introduction to the world of shares and investing. We will connect some dots about dividends, yield, and other types of shares in the next instalment along with some interesting information about how long it will take to double your investment.