Buying stock in a publicly traded company, an individual investor becomes an owner. In doing so, you are able to participate in the company’s growth over time and, in many cases receive a share of the company’s profits in the form of dividends.
Owning equity in a company is the most common and accessible means by which wealth is created. However, the investment world is divided between owners and lenders.
Lenders – bonds, or debt securities
In the most simplest terms, a security is an investment in that represents either an ownership stake or a debt stake. Buying shares of a company’s stock and becoming a part owner is an ownership stake.
A debt security is usually acquired by buying an insurer’s bonds. The insurer can either be a company or government. So, you are wither buying a company bond or a government bond. A debt investment is a loan to the insurer (company or government) in exchange for interest income and the promise to repay the loan at a future maturity date.
Unlike the purchase of stock, a debt security does not grant any ownership (equity).
The two main types of equity securities are common stock (also called common shares or ordinary shares) and preferred stock (also known as preferred shares or preference shares).
Common Stock vs. Preferred Stock
Common stock is equity (ownership) in a corporation. Companies issue stock to raise money aka capital. Whatever a company owns (assets) minus it’s liabilities belong to the owners (stockholders).
Each share of stock entitles the investor to a portion of the company’s earnings and dividends. Shareholders also have a proportionate vote in major management decisions. For example- these management decisions may include electing members to the board of directors at the annual meeting.
Most companies are organized in a way that their common stockholders regularly vote and elect individuals to a board of directors. The board directors oversee the company business. By electing a board of directors, stockholders contribute indirectly to the company’s management, but are not involved in the daily operations.
For example: If a corporation issues only 100 shares of stock, each share represents 1% ownership in the company. An investor that owns 10 shares would own 10% of the company. An investor that owns 50 shares would own 50% of thew company.
When most people are speaking of stocks, they are generally referring to common stock. However preferred stock also represents equity (ownership) in a corporation but usually does not have the same voting rights or appreciation potential as common stock. Preferred stock normally pays a fixed quarterly dividend and has priority claims over common stock– which means that common stockholders cannot receive a dividend until the preferred shareholders have been paid. In the even the company goes bankrupt, preferred stockholders have a prior claim on any remaining assets.
As previously stated, preferred stock is an equity security because it represents a class of ownership in the issuing corporation. However, it does share some characteristics with a debt security.
All stockholders, even preferred stockholders are owners of a corporation, not creditors.
Just as with debt securities, the rate of return on a preferred stock is fixed rather than subject to variation as with common stock. As a result, the price tends to fluctuate with changes in interest rates rather than with the issuing company’s business prospects unless, of course, drastic changes occur in the company’s ability to pay dividends. This concept is known as interest rate risk, also called money rate risk.
Preferred stock reacts to the market more like a bond because with its fixed dividend payment, its price is sensitive to interest rate changes.