1) Two Classes of
Stock
Two Classes of Stock
We live in a class-ridden
society. Stocks too have their two major classes or types: ordinary and
preference.
Ordinary stocks, sometimes also called equity stocks or common stocks, are
really for the general public without any bar. You, me and just anyone can
buy them (and proudly say we have a stake in the company).
Before we step further, let's clear one thing upfront. By equity we mean
stocks, right? And vice versa? We use equity and stocks interchangeably.
Equity refers to ordinary stocks. And that�s what concerns us here because
only ordinary stocks can be purchased by people like you and traded on the
stock exchanges. Stocks again refers to equity. Unless we mention
preferred stock, stock is always the other type meant for us. OK?
Individual investors can also acquire preference stocks, just that
companies in India haven�t bothered to offer them so far to the general
public.
Holding equity (savvy way of saying you own those pricey little share
certificates) entitles you to a share of the earnings and the assets of a
company. What that means is that if a company records profits for a year
you are entitled to a share of the profits. The share of the profits or
earnings the company is decides to give you is called dividend.
How nice! But did you get the catch when we said on `entitled� and
`decides to give you�? Because what happens is that ordinary shareholders
will only get the dividend after everyone else, i.e. preference
shareholders have settled their share of the earnings. So, if the company
chairman says no dividends this year, you can't kidnap him till he comes
out with your dividend unless of course, you have no other way to earn
infamy.
Preference shareholders are privileged guys. They get their share of the
earnings before the ordinary shareholders. In other words, preference
stocks will always have an assured dividend. Whether those shareholders
actually get paid depends on whether the company has enough resources to
pay up. If that was not enough, those privileged guys also have the
"added" advantage. All their missed dividends keep getting added while for
ordinary shareholders dividends once missed are missed forever! And when
the company does declare windfall profits, it will first pay the
cumulative dividends of the preference shareholders and then the ordinary
shareholders.
Cheer up, the flip side is, those privileged guys don't get to trade their
stocks on the exchanges That�s because though legally preference shares
can be listed on exchanges, nobody has ever done so. This means that
preference stocks don't appreciate as much as ordinary stocks do.
Let's say quits! Enough of investing and now you want your money back. To
redeem is to get back the principal (i.e. the price at which you
purchased) in any security like a bond, a preference stock, or a mutual
fund share before or at the time of maturity. For a company or an
institution that issued you the security, redemption then means, quite
simply, buying back the security.
Ordinary stocks are not redeemable. Once out of the company's kitty, the
company doesn't have to pay back its equity stocks until it shuts down.
Hence, for a company, equity shares provide it permanent capital. One fine
day if you decide to get rid of the stocks of a company, you can�t walk
into the company and ask them to buy back or redeem the shares from you.
What you can do, and as the law permits, is to transfer those ordinary
shares to someone else. A job that your broker will do for you. Unless you
are too benevolent, transfer doesn�t mean you hand over your share
certificates to your broker. You actually sell it for a price, and
sometime make a killing out of it. As to how one can make money out of
stocks, a little later.
Preference shares are redeemable. The company can repay the shareholder in
return for the stocks. The amount repaid in most cases includes the
premium over the current market price of the stock. Usually preference
stocks are issued to shareholders for a particular period. A company can
also, if it feels it's too costly to keep paying dividends, buy back
preference stocks after serving a proper notice to the stockholders.
If you have realised preference stocks are not exactly pure stocks. They
are a cross between equity stocks and bonds, which have an assured
dividend. There are some preference stocks, however, which are
non-cumulative; the dividend lapses if the company is unable to pay it.
Preference stocks are generally tradable. There are some convertible types
that allow the shareholders to convert such stocks into ordinary shares
after a particular period or after fulfilling certain conditions. There
are also a non-redeemable variety of preference stocks where such stocks
can only be redeemed at the time of a company's liquidation. Preference
stocks are generally given out to banks, financial institutions and rich
guys with high net worth.
Holding equity also gives you the right to vote for the company's board of
directors. The number of votes depends on the number of stocks you hold.
On a special gathering every year called the annual general meeting (AGM)
you also get to vote for or against the company's annual report placed
before all shareholders. However, preference shareholders don't get to
vote in the AGM.
All that is solid melts into air. Apparently healthy companies sometimes
wind up all of a sudden. As a part owner, all shareholders get paid
according to their stake in the company. Ordinary shareholders will be the
last to get paid. All debts of the company must be settled first,
including the claim on the assets of a company by the preference
shareholders. It could well be that ordinary shareholders get nothing if
no assets are left after clearing off debts and paying preference
shareholders.
As an equity shareholder you also have what are called pre-emptive rights.
That means that in case a company decides to offer new equity shares
existing equity shareholders are offered first before the company can go
to the open market with a public offering.