This section covers fundamental knowledge that investors need to know when investing in stocks (also known as equities).
What are equities?
When you purchase a common stock a company, you acquire a stake in the ownership of that business, and that is known as equity. As an owner, you become entitled to capital gains if that stock rises, as well as any dividends. At the same time, should the company go bankrupt, as an owner you stand to lose your investment. In fact, in bankruptcy proceedings, common shareholders come last when it comes to liquidation proceeds. Any claims for taxes and wages receive priority, then come secured creditors, unsecured creditors, preferred stock shareholders, and, at the very end, common shareholders. However, common shareholders hold no personal financial liabilities should there be not enough money left to pay others.
Investing in equities
When investing in equities, investors take different approaches. One approach, for example, is going for growth companies. Usually, these stocks are expected to grow much faster than the overall economy, and are expected to produce capital gains (appreciation in the stock price). Typically, these companies trade at high valuations such as P/E’s (Price-to-Earnings ratios).
A different approach is to buy value stocks. These companies tend to trade at lower valuations than their estimated intrinsic values suggest. Often, these are companies in traditional industries and companies that pay dividends. These stocks tend to trade at low P/E’s and often below their Book Values.
Some investors like to place their bets on distressed stocks. Typically, these are companies in trouble, whether due to economy or specific industry factors, or their own financial and operational problems. The investors who invest in these companies bet on a future recoveries and subsequent substantial rises in value.
Classes of common stocks
When it comes to common stocks, there can be several different classes issued by a single company such as A, B, and C. Often, all these classes will have equal ownership stakes but different voting rights. (There are exceptions, however, such as Berkshire Hathaway class A and class B shares, where the former are much more expensive and carry more voting rights.)
Usually, class A shares have one voting right per each share, and it will differ for other classes. How this works is different among companies, therefore, investors need to check each company individually. (Typically, when buying shares on the market, class A shares are traded).
For example, at Alphabet (formerly known as Google), class A shares, which are held by investors, have one vote per share, but class B shares, which are held by the top executives of the company, have 10 voting rights per share. Finally, class C shares, owned by employees, have no voting rights.
Another example is Snapchat. Here, class A shares that are available to investors have no voting rights, and that’s quite unusual. Class B shares are held by the executives and some early investors, and have one vote per share. Meanwhile, class C shares are held by company founders and have 10 votes per share.
Treasury stocks are stocks bought back from investors by the issuing company. Treasury stocks have no voting power and are ineligible for dividends. By buying these stocks, companies effectively reduce the float of shares in the market, thus technically increasing each shareholder’s share of ownership, which often leads to increases in stock prices.
This is the total number of shares that can be issued- unless it is amended with the approval of shareholders.
Typically, these stocks are offered to employees as forms of incentives. Restricted shares can’t be sold until specific conditions are met such as the vesting period.
This is also called free float or public float. It represents the number of stocks that can be traded at any time. Therefore, it doesn’t include restricted stocks.
These are the stocks that are held by shareholders (free float) plus restricted stocks. However, treasury stocks aren’t included.
Outstanding shares= free float + restricted stocks – treasury stocks
Par value of a stock and no-par value stock
Par value of a common stock is a rather symbolic number and has no effect on current market price. A while ago it was a price at which shares were issued to investors, but now new share issues come with no-par value or a symbolic value of $0.01. That doesn’t mean this is the price of the Initial Public Offering (IPO).
It’s a different story for bonds where the par value matters since it is the price at which bonds get redeemed at maturity.
In the United States, stocks trade under symbols. For example, AMD stands for Advanced Micro Devices. In some other countries, stock symbols are numerical. You can always search for symbols by using company’s name. Exchange-listed stocks (i.e. NYSE) will typically have 1- to 3-letter symbols (although there are exceptions), while NASDAQ and OTC BB (Over-the-Counter Bulletin Board) stocks have four letters.
Sometimes these symbols have additional identifiers. When you see a 5th letter of “Q” it means the company is in bankruptcy. The 5th letter “D” represent a new issue, but often it is added for a while to the symbol when a stock has a reverse split (outstanding shares actually get reduced). Often, this happens with penny stocks.
Also, “A” stands for class A shares and “B” for class B shares, but often you will not see it as part of a standard symbol (only some market data services display it). When it comes to “F” as a 5th letter, it represents a foreign stock, while “R” represents a rights issue. For American Depositary Receipts (ADRs), “Y” is used. When you see “W” as the 5th letter, know that it stands for warrants.
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