The word “stock” is a term we hear growing up, sometimes in reference to ownership in a company, sometimes relative to the stuff that goes into soup. Only over time, or after a freshman finance class, do we come to learn the difference, and what it really means in a financial context.
Some folks, even those who trade in stocks, go their entire lives without really understanding a more precise definition. Because there are several types of stock, and while it may not affect your trading experience, it’s good to know what they are.
There are several dimensions to consider when it comes to breaking down stock.
First, there is privately held stock and publicly held stock. Privately held shares are shares of ownership in non-publicly traded companies. Some are as small as a janitorial service, others massive family-owned enterprises. Any firm that has been incorporated has its capitalization represented by shares of stock, even if only one person owns them all.
It’s possible to own such shares through private financings, but as a rule, the term “stock” in context to the stock market refers to shares in companies that are publicly traded, either on an exchange or through over-the-counter markets.
There are two primary classifications of publicly traded stock.
Traded shares of stock are deemed to be either common or preferred, and they are quite different in nature. Let’s begin with the latter, because in essence common stock refers to all the outstanding shares of a company that are not otherwise preferred or restricted.
Preferred shares, some of which are indeed traded on exchanges, have first claim on dividend payouts and, in the event of liquidation of assets or other distributions, they are also first in line for those.
Which means, they get their payout before the holders of common shares.
In the case of dividend payouts, preferred shares have a fixed amount attached, which doesn’t fluctuate according to the firm’s profitability. Common shares pay dividends according to profitability, which means that they could actually pay out even more in case of a windfall year.
Because of this, preferred shares usually trade in a narrow price range, since their value is largely determined by dividend rate of return. Since their payout per share is fixed, the price of the stock usually shows very little movement.
Preferred shares are often held by original investors in new enterprises, and by officers, as well as investors who are income-oriented and are looking for a solid return backed by the security of the issuing company. While the preference aspect sounds ominous, in most cases preferred shares comprise a small minority of a firm’s capitalization, and when dividends or distributions occur there is almost always sufficient funds to cover those shares and all outstanding shares.
Common stock shares are, literally, all other shares outstanding, and they comprise the vast majority of a firm’s traded securities and capitalization.
Restricted Common Shares
Sometimes common stock can be deemed restricted, or Rule 144 stock. This means that, once awarded, it cannot be traded or sold for a specified length of time. After that date, the stock becomes unrestricted and trades like any other share of common stock.
Restricted shares are usually issued as part of a capital payment when a company is sold, in lieu of cash. When Company A sells to Company B, for example, the holders of Company A stock would receive some combination of cash and Company B stock, the latter being restricted for a specified time. The rationale for this is to avoid sellers flooding the market with Company B’s shares right after the sale closes, which would artificially suppress Company B’s market value.
For the most part, the word “stock” refers to unrestricted common stock of publicly traded companies. Those who deal in preferred or restricted shares most likely already know the difference, so the discussion becomes academic.
But like any aspect of the stock market, the more you know the better off you’ll be, and this includes and understanding of the different types of stock, as well.
