Benefits and Liabilities

A stock represents partial ownership in a publicly traded corporation.  There are two main types of stock: common and preferred.  Common stock is what is traditionally traded in the stock markets.  With common stock ownership come a few rights, the biggest being a share in company profits.  This can be reflected in one of two ways: an increase in share value or the payment of dividends.  When a stock price increases, an individual’s stake in that company is worth more.  This means that stock can be sold at a higher price than it could have been previously, resulting in a higher return for the seller.

Dividends are a little more complex.  First, it must be understood that dividend payment is not mandatory.  Only if a company’s board of directors approves the payment of dividends will they be issued.  Payment comes from current, post-tax earnings or from previously retained earnings.  Amount distributed is directly proportional to shares of stock owned.  For example, if an individual holds 1% of a company’s stock, they will receive 1% of the total dividend paid.  Usually, dividends are paid in cash.  If it is determined that $1.00 in dividends will be paid per issued share, an individual who owns 100 shares will receive a check for $100.  There are also stock dividends.  Dividends portioned in this manner are given out as shares of stock.  Instead of receiving $100 for 100 shares, the shareholder would receive $100 worth of stock instead.  If the company expands significantly, this free stock could be worth much more than a simple cash dividend.  Cash dividends, understandably, are much more reliable since they are paid in concrete terms.

The payment of dividends is reflected in the price of stock.  Two days before the actual payment of dividends, stocks, in theory, are sold ex-dividend.  In the above example, stocks previously selling for $45 per share should drop to $44.  A dividend of $1.00 per share would cause a drop of $1 per share.  I say ‘in theory’ because market prices are ultimately subject to the demand of investors.  While this drop in price is most logical, it is not always the case.

Another right that comes with stock ownership is participation in annual meetings.  Shareholders are given a certain number of votes dependent on how much stock they own.  This way, the true owners of the corporation are given some insight as to how the business is run.

Preferred stock has a couple advantages over common stock.  In addition to all the rights that go along with common stock, preferred stockholders receive their entitled profits first.  Also, preferred stockholders get first dibs on asset allocation if the company goes under.  Preferred stock offers a partial layer of protection from the liability that comes from owning stock in general.

This liability is referred to as “limited” because the investor is only responsible for his or her own investment.  In no way are shareholders responsible for paying off debt in the event of company liquidation, they just lose the money that had been invested.

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