Ordinary shares (also called common shares) make up the majority of shares traded on ASX. Special rights are not granted to ordinary shares. Ordinary shareholders often have the same voting rights at general meetings of the business as other ordinary shareholders. They also typically have the same rights to dividends and asset distributions upon the company’s liquidation.
The main advantage to investing in ordinary shares is voting rights, as ordinary shareholders have the option to participate in internal corporate governance through voting. Because a small amount of ownership in the issuing company is provided when owning ordinary shares, shareholders have a certain amount of say in how the company is run and are allowed to partake in votes about important decisions, such as the appointment of a board of directors. With each individual share owned comes a single vote; therefore, voting power becomes weightier when more shares are owned.
For someone who is purchasing a very small percentage of a company’s stock, this benefit may not be extremely important, as their votes will not be very impactful on the decisions of the company’s operations. For these investors, the main benefit of investing in ordinary shares is found in their potential for capital gains and dividends, which outline the two ways a shareholder can profit from their ownership.
Capital gains
Investing in the share market is quite a simple way to generate income. Although there is never a guarantee of profits, almost anyone can create an online trading account to buy and sell shares of a publicly traded stock.
Investing in ordinary shares has the potential for large capital gains, whilst the potential loss is limited to the amount that was originally invested. The main idea of these shares is to sell the shares at a higher price than the original purchase price. For example, if $1000 was invested five years ago into a business that was worth $5 per share, the shareholder then owned 200 shares of that company. Five years later, the share price for that business is now worth $17.50, meaning that the original $1000 that was invested is now worth $3500 – a 250% increase over five years. This is called capital gains. Investors are still required to pay capital gains tax on their profit.
However, the opposite can also happen; shareholders may experience a capital loss on their investment if they sell shares for less than they paid for them. For example, if $1000 was invested five years ago into a company that was worth $2 per share, but five years later the share price for that business is now worth $1.20, the original $1000 invested is now worth $600 – a 40% decrease over five years. This investor has a capital loss of $400 over the period of five years. Investors are able to claim this capital loss through their tax return.
Dividends
When a company turns a profit, it often rewards its investors by paying a small amount of that profit to each shareholder, depending on the number of shares owned.
Whilst this dividend is not guaranteed, as an ordinary share, many companies pride themselves on consistently paying higher dividends each year. This encourages long-term investment into their company, and motivates new shareholders to invest in the company. Shareholders have an option to reinvest their dividends or receive them as income.
Companies will announce to the market when they intend to pay a dividend, and how much that divided will be. They will generally send a letter to shareholders with this dividend information. This is often referred to as declaring a dividend. The dividend can be anywhere up to 20%.
There are some drawbacks associated with this type of benefit. For one thing, there is no guarantee that dividends will be paid (unlike with preferred shares, where fixed percentage dividends are guaranteed). Although you are entitled to dividends following the payment of preferred shareholders, this is not a set rule. Instead, some businesses may set aside these profits for future investments. Because of this, you assume a greater financial risk. If you want to receive consistent income from your investment, preferred shares could be a better option. We will be looking at these in more detail in the next section.
Another drawback is the risks associated with liquidation. In the event of a liquidation, ordinary shareholders would receive the final payment. This disadvantages ordinary shareholders, since they may receive little to no return on their investment if the company’s assets are used to pay down its debt.