8.2 Common Shares

Common shares provide a reliable measure of overall performance in the capital markets. At the close of each trading day, market participants assess how the markets have performed. To measure that performance, they refer to various stock market indexes, which primarily track the performance of a basket of common shares representing the most visible and easily accessible investments.

Common shares form the backbone of many investment portfolios and are a major component of pension funds, mutual funds, and hedge funds. Unlike many other types of investments, common share ownership provides a number of inherent rights, advantages, and disadvantages, with which investors should be familiar.

Closely related, but with some key differences, are preferred shares. Preferred shares are a staple investment in the Canadian market largely due to the fixed-income streams they generate. While common share ownership provides an ownership position in a company, preferred shares offer various structures and characteristics designed to appeal to different investors for different reasons. Preferred shares share many similarities with bonds, as discussed in the chapter on fixed-income securities.

In this chapter, we cover the benefits and risks of investing in both common shares and preferred shares, describe different types of preferred shares, and explain how and why investors use them.

Common Shares

Features, Benefits, and Risks

Features of Common Shares

1. Ownership Stake: Common shareholders, who may be individual investors, businesses, or institutional investors, are considered the owners of a public company. If the venture prospers, shareholders benefit from the growth in the value of their original investment and dividend income. However, if the business fails, shareholders may lose their entire investment. This downside risk is why common share capital is sometimes referred to as venture capital or risk capital.

2. Position on Assets: In the case of bankruptcy, common shareholders have a relatively weak claim on the company’s assets. Senior creditors (such as banks), bond holders, debenture holders, and preferred shareholders have prior claims.

3. Dividends: Unlike the payment of interest on outstanding debt, common share dividends are payable at the discretion of the board of directors and are not guaranteed.

4. Evidence of Ownership: Shares are often registered in street certificate form, meaning they are registered in the name of the securities firm rather than the beneficial owner. This form increases the negotiability of the shares by making them more readily transferable.

5. Clearing and Settlement: CDS Clearing and Depository Services Inc. (CDS) offers computer-based systems to replace certificates as evidence of ownership in securities transactions, almost eliminating the need to handle physical securities.

6. Trading Units: Stocks trade in uniform lot sizes on stock exchanges, with a standard trading unit typically consisting of 100 shares. A group of shares traded less than a standard trading unit is called an odd lot.

Impact of Stock Splits and Consolidations

Stock Splits

Stock splits increase the number of shares outstanding by dividing each existing share, which lowers the price per share but does not change the overall market capitalization. This action makes shares more accessible to individual investors by reducing the per-share price.

Stock Consolidations (Reverse Splits)

Stock consolidations reduce the number of shares outstanding by merging multiple shares into one, increasing the price per share while keeping the market capitalization constant. This is often done to meet minimum price requirements for continued listing on stock exchanges.

Key Takeaways

• Common shares represent ownership stakes in public companies and provide potential for growth and dividend income but come with the risk of total loss.
• Common shareholders have lower-priority claims in the event of bankruptcy, following creditors and preferred shareholders.
• Dividends on common shares are not guaranteed and are paid at the board’s discretion.
• Common shares offer negotiability and liquidity through electronic clearing and settlement systems such as CDS.
• Trading shares can occur in standard units (usually 100 shares) or odd lots (fewer than the standard unit).
• Stock splits and consolidations can impact share accessibility and market listing requirements but do not change the overall market capitalization or value position of the investor’s holdings.

Frequently Asked Questions (FAQ)

Q: What differentiates common shares from preferred shares?

A: Common shares provide ownership in the company, voting rights, and potential for dividend income and capital appreciation, but dividends are not guaranteed. Preferred shares typically offer fixed dividends and have priority over common shares in asset claims, making them similar to fixed-income investments.

Q: How does a stock split affect my investment?

A: A stock split increases the number of shares you own while reducing the price per share proportionally, leaving the total market value of your investment unchanged.

Q: What happens if a company I invested in goes bankrupt?

A: In the event of bankruptcy, common shareholders are at the bottom of the priority list for claims. Assets are first distributed to senior creditors, bond holders, and preferred shareholders, often leaving little to no remaining value for common shareholders.

Glossary

• Common Shares: Units of ownership in a public company, providing voting rights and the potential for dividends and capital appreciation.
• Preferred Shares: A class of ownership in a company that provides a fixed dividend and higher claim on assets than common shares.
• Dividends: Payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders.
• CDS Clearing and Depository Services Inc. (CDS): A Canadian organization that provides clearing, settlement, and depository services for trades in the Canadian securities industry.
• Stock Split: An increase in the number of shares outstanding by dividing each existing share, which lowers the per-share price and does not change the total market capitalization.
• Stock Consolidation (Reverse Split): A process that reduces the number of shares outstanding by merging multiple shares into one, increasing the per-share price while keeping the overall market capitalization constant.

In this section

• 8.2.1 Benefits And Risks Of Common Share Ownership
  Understanding the benefits and risks of common share ownership is crucial for investors seeking to maximize returns and minimize risks. This guide explores key aspects such as capital appreciation, voting privileges, and limited liability, alongside potential risks like market volatility and dividend uncertainty.
• 8.2.2 Capital Appreciation
  Understand the concept of capital appreciation in the context of common shares, and how it impacts investors' decisions.
• 8.2.3 Dividends
  Explore the essential details about dividends in equity securities, including dividend policy, payment methods, ex-dividend dates, dividend reinvestment plans, and stock dividends.
• 8.2.4 Voting Privileges
  This guide explores the rights of shareholders in the context of voting privileges, focusing on various types of shares, including restricted shares, and their impact on shareholders' participation in corporate governance.
• 8.2.5 Stock Splits And Consolidations
  Understand the basics and strategic importance of stock splits and reverse stock splits (consolidations) for publicly-traded companies. Learn how these actions can influence share prices and investor perception.
• 8.2.6 Reading Stock Quotations
  Learn how to read and interpret stock quotations for listed and unlisted stocks traded on stock exchanges and over-the-counter (OTC) market.