Ordinary shares, also known as common shares, are defined as shares of a company that gives shareholders the right to vote in the company’s meeting and an income in the form of dividends from the corporation’s profits. Ordinary shares are most commonly issued in the market as a means for a company to raise capital. They indicate that a shareholder has voting rights. The stockholders have ownership in a company, allowing them to elect members to the board of directors and vote on corporate policies.
You can buy and sell ordinary shares on the stock market. The number of shares you own dictates the weight of your voting rights at a company’s annual general meeting (AGM). It also determines how considerable a proportion of a company’s profits you’re entitled to. For example, if a company only had ten shares in issue and owned five of them, you would own 50% of the company. However, in reality, stock market-listed stocks have millions of shares in circulation.
Types of Ordinary Shares
Ordinary shares can be categorized into three main categories depending upon their characteristics:
- Voting/Non-voting shares: These types of ordinary shares determine the degree to which the shareholder gets to vote on major decisions regarding a company’s policies. While voting shares offer voting rights, non-voting shares mean ownership but differential or no voting rights.
- Sweat equity shares: These are typically offered by companies as compensation or incentive to employees and senior executives.
- Right shares: Current shareholders in a company are offered the advantage of purchasing further shares before these shares become open for trade in the market. These are known as right shares.
Advantages of Ordinary shares
Some important advantages and rights of ordinary shares are:
- Voting rights: Ordinary shareholders have the right to vote in the company’s general meeting. Each share carries the right to one vote. Shareholders can exercise control by electing the board members, who will oversee the major decisions and policies implemented by the management. Your vote is in proportion to the number of shares you own.
- Ordinary shares give you a claim to the income and assets of the company. By holding ordinary shares in a company, you claim the income and assets the company makes. A company can only fulfill this claim once it settles all its obligations with creditors and preference shareholders.
- No maturity date: This means they exist into the future unless the company delists, another company buys it over, or it goes bust. By investing in ordinary shares, you can pass them onto your family when you pass, or you can choose to sell them whenever you want.
- A company can’t dilute your ordinary shareholding. Your share of a company stands. If a company you invest in decides to issue more shares to raise money, it has to offer you the right to buy more shares in proportion to your current ownership first. Companies tend to do this through rights issues.
- Dividend Payments: Ordinary shareholders are entitled to a share of the profits in the form of a dividend. However, the dividend payments are not based on a fixed percentage rate, and it is recommended and decided by the board of directors.
- Your losses are strictly limited to ordinary shares. By investing in shares, you know that you will receive nothing in the unlikely event the company’s share price falls to zero or low. You can’t lose more than you invested in the first place. This makes it a safe investment option in this manner.
- Limited Liability: Ordinary shareholders have limited liability. In other words, their liability is limited to those shares. They cannot be forced to pay anything out of their own money in the event of bankruptcy. They are fully protected against any financial obligations incurred by the organizations.
Disadvantages of Ordinary shares
Ordinary shares can be a risky investment option if one does not proceed with caution, keeping in mind all the market risks and disadvantages of ordinary stock investments.
- The business generally loses out over its authority and controllership whenever it raises finance through the issuance of ordinary shares. The company may find itself in a difficult position to get even ordinary resolutions to pass if the ownership of the share rests with unsupportive shareholders.
- Ordinary share prices are volatile, especially for start-up companies. Their value can fluctuate without notice, making it difficult to assess their success even when the business is doing well.
- There can be no dividend payable during or at the end of the year. If the company goes into bankruptcy, shareholders can lose the entire investment amount.
- Dividends are never fixed or predefined. They are declared year on year as per the management decision. If the company decides to plow back the profits, there will be no dividends for the ordinary shareholders.
- Though ordinary shareholders have limited liability, ordinary shareholders are paid last at the time of liquidation, i.e., if anything remains after meeting all the liabilities.
- Share prices of ordinary shares are mainly decided by the market forces, which are volatile and can lead to a lot of fluctuation in the value of the shares.
- The cost of equity finance is typically higher than the cost of debt finance because:
- The administrative costs of issuing shares are expensive
- To investors, shares are riskier than debt, so shareholders expect a higher return
- Dividends paid are not tax-deductible, whereas interest payments can be used to reduce the company’s taxable profits
Should you invest in ordinary stocks?
Ordinary stocks come with significant growth potential, and investors can make the most of it if they park their funds in these investment options for the long term. However, since common stocks have a significant risk associated with them, they may not be suitable for risk-averse investors. Additionally, the prices of these shares are subject to volatility and thus tend to fluctuate frequently. Hence, it can be said that investors with a strong risk appetite and a significant investment horizon would find common stocks a viable investment option.
Ordinary shares are distinct from another type of stocks called preferred shares whereby dividends are guaranteed to the shareholders. Learn about the differences between them.