With the wide range of stock options available, investors rely on current market information and the financial standing each company has within the marketplace to make investment decisions. As different types of stock carry their own set of risks and potential for profit, the advantages and disadvantages of investing in common stock can vary depending on a stockholder's perspective and the types of results he wants.
Types of Common Stock
When someone purchases shares of common stock in a company, she owns a certain percentage of the equity built up in the company. In effect, a stockholder invests in a company's ability to generate profits and pay dividend earnings on shares purchased. The amount of equity built up in a company influences the type or quality of common stock a company can offer. Companies with long-standing histories and strong financial portfolios typically offer blue chip stocks. Companies that specialize in the utilities industry offer another type of stock that holds its value well. Companies that show established growth and emerging growth also offer their own grades of common stock. These differences between common stock affect the types of advantages and disadvantages a stockholder will encounter when purchasing different types of stock.
One of the main advantages in investing in common stock has to do with the profit potential stocks offer. Compared to other types of investments, certain types of stocks can generate annual returns over and above their purchase price. In general, common stock produces earnings through capital gains and through dividend payments. Capital gains occur when a company's stock increases in value while dividend earnings result from profits earned over and above what a company needs to operate. From a stockholder's perspective, the stronger, more stable blue chip and utility stocks provide a consistent source of dividend earnings though little potential for capital gain. Stockholder's looking for capital gains and dividend earnings may fair better with established or emerging growth stock options.
Along with the profit potential available through common stock investments, stocks also carry a certain level of risk. In effect, the higher the potential for profit the higher the degree of risk involved with a particular stock. The structure of a stock investment typically allows for higher payoffs when a high probability for loss exists. From a stockholder's perspective, this disadvantage becomes most apparent when an emerging growth stock shows tremendous profit during one period and then bottoms out shortly thereafter. In effect, common stock investments hold a certain degree of volatility, making it difficult to predict where a stock's earnings will end up from period to period.
Stockholders may encounter certain advantages and disadvantages in terms of how liability applies for those who own stock in a company. Advantages include the limited legal liability involved with owning common stock in cases where a company becomes involved in illegal activities. Another advantage has to do with the potential for loss when investing in common stocks. In effect, any losses suffered cannot exceed the initial amount invested. From a stockholder's perspective, certain disadvantages exist in terms of the actual amount of information an investor can obtain on a company. Even as a partial owner of a company, a stockholder has limited access to information regarding the company's bookkeeping records or any potential problems on the horizon. And lastly, when a company does generate profits, as partial owners, stockholders get paid after operational expenses have been paid.