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Understanding And Investing In Common Stock

Jan 3, 2008
At a great penny worth pause awhile; many are ruined by buying bargains. -POOR RICHARD

A corporation is an artificial entity, created by law, and endowed with certain rights and privileges, among which is the right to issue shares of ownership called "common stock." The amount of stock authorized is stated in the corporate charter, and the amount to be issued and outstanding is determined by the board of directors. Such shares of stock represent ownership of the total assets and are originally issued to persons who contributed their services and/or funds as part owners.

However, these original owners may have found it desirable to sell all, or only part, of their holdings to others, who then, in turn, assume the status of owners, the transfer being easily effected on the books of the corporation. Such shares are termed common stock or capital stock, the former term being in most general use, and the total ownership is divided into a number of units called shares.

EARNINGS AND DIVIDENDS

Since the shareholder is a part owner in the business, he naturally has a strong interest in the ability of the company to earn money upon his invested capital; consequently, the earnings per share assume great importance. Some corporations issue quarterly or semiannual statements of the state of their business, so as to keep the stockholders informed; others do not, so that the shareholder may have to wait until the annual report is received, or look up the most recent reports to the Securities and Exchange Commission as printed in one of the several investment advisory services.

The prime reason for such keen interest in earnings is that the dividends per share, as declared by the board of directors, will depend upon the earnings; should earnings be very poor, there may be no dividend at all; should earnings be quite modest, the dividend may be small; should earnings be good, then dividends will be more generous.

We hasten to add, however, that the total earnings are not paid out as dividends, because the company must satisfy its current financial needs, and also because a certain amount of the earnings must be put back into the business in order that it may continue to grow. As a result, the "payout percentage," as we may call it, varies greatly from one company to another.

In some cases the payout may be extremely generous, ranging from 50 to 70 per cent of earnings; in other cases it may be extremely conservative, being in the 20 to 40 per cent range, this latter being especially true when it seems necessary to conserve capital funds for which there may be an immediate and pressing use.

In the case of the so-called "growth" stocks, there may be no dividend at all, or at most it may be very small; such a business may require all earnings to be plowed back in order to continue to grow and to expand.

Perhaps the most common error into which many common-stock owners fall is relative to dividends. Should business conditions be good, then a given company may enjoy continued success, and its dividends may be steady and even increase; should general business conditions take a turn for the worse, it may happen that earnings will fall sharply and the dividend rate may be reduced or perhaps even suspended for a period of time.

It may be emphasized here that there are a few exceptions to the above statements, because certain essential industries (utilities are a good example) feel such fluctuations in business conditions far less than others; since they represent what might be called basic or "defensive" stock ownerships, their dividends may continue without interruption, although a change in rate is sometimes justified. There are numerous public utilities which have paid steady dividends for over half a century, which is a strong recommendation of them for the investor of modest means.

Stocks may be the very thing you should start to invest in.
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