Common Stock

Common stock represents an ownership stake in a corporation. Common stockholders are the true owners of the company, and that ownership comes with a bundle of rights the exam expects you to know:

• Voting rights: shareholders elect the board of directors and vote on major corporate matters such as mergers and changes to the corporate charter. They do not vote on routine decisions like dividends or stock splits, those are the board's call.
• Dividends: shareholders may receive dividends, but dividends are never guaranteed; the board has to declare them.
• Preemptive rights: where a company grants them, the right to buy enough new shares to maintain your proportional ownership before those shares are offered to the public.
• Limited liability: the most you can lose is what you invested, no more.
• Transferability: shares can be freely bought and sold.

One common way to classify a stock is by its market capitalization, which is simply the share price times the number of shares outstanding. By size, companies fall into a few buckets:

• Large-cap ($10 billion and up): established companies with stable earnings, like the names in the S&P 500. Generally lower risk and lower growth potential.
• Mid-cap ($2 billion to $10 billion): a middle ground of moderate growth and moderate risk.
• Small-cap ($300 million to $2 billion): more growth potential but more volatile and less liquid, and tracked by the Russell 2000.
• Micro-cap (under $300 million): very high risk and very illiquid, often trading over the counter.

Growth, value, and income stocks

Stocks also get sorted by their investment character. Growth stocks are expected to grow faster than the market, tend to pay little or no dividend (they reinvest instead), and carry higher P/E ratios. Value stocks trade below what investors think they are worth, often pay dividends, and carry lower P/E ratios, the bet being that the market eventually recognizes their true value. Income stocks pay consistently high dividends, the classic examples being utilities and REITs.

Dividends come in more than one form, and the exam tests the differences, especially the tax treatment:

• Cash dividends are the familiar kind, paid out of earnings in cash. They are taxed, either as ordinary income or, if they qualify, at the lower qualified-dividend rate.
• Stock dividends pay you additional shares instead of cash, distributed proportionally (a 10% stock dividend on 100 shares gives you 10 more). The share price adjusts down to match, so your total value is unchanged. A stock dividend is not taxable when received; instead it lowers your cost basis per share.
• Return of capital is a distribution that exceeds the company's earnings. It is not immediately taxable; it reduces your cost basis, and once that basis hits zero, any further distributions are taxed as capital gains.
• Property dividends pay out company assets, such as shares of a subsidiary. They are rare but testable.

Whether you receive a declared dividend comes down to one date: the ex-dividend date. To get the dividend, you have to own the stock before the ex-date. Four dates define the timeline:

• Declaration date: the day the board votes to pay the dividend.
• Ex-dividend date: the first day the stock trades without the right to the dividend. Buy on or after this day and you do not receive it.
• Record date: the day you must be a shareholder of record to receive the dividend. Under today's T+1 settlement, the ex-dividend date and the record date fall on the same day.
• Payment date: the day the cash actually goes out.

On the ex-dividend date, the stock price typically drops by roughly the amount of the dividend, since new buyers no longer have a claim to that payment.

Common stockholders elect the board of directors and weigh in on major corporate matters. There are two ways the voting math can work, and the exam loves to ask which one helps which kind of shareholder.

Statutory (regular) voting

Under statutory voting you get one vote per share, per seat, and the votes for each seat are separate, you cannot pile them onto one candidate. The practical effect: a shareholder who holds a majority of the shares can elect every seat on the board, which is why statutory voting favors large, majority holders.

Cumulative voting

Cumulative voting gives you shares times the number of seats in total votes, and you can spread them however you like, including putting them all on a single candidate. An investor with 100 shares voting for three seats has 300 votes and could cast all 300 for one director. Because it lets a small holder concentrate votes, cumulative voting benefits minority shareholders, who can win at least one seat they could never take under statutory rules.

Proxy voting

A shareholder who cannot attend the annual meeting can vote by proxy, a written authorization letting someone else cast their votes. Proxy solicitation is regulated by the SEC.