Common Stocks
WHAT IS IT?
Common stock represents an ownership interest in a corporation. Each shareholder is entitled to a proportionate share of the control, profits, and assets of the corporation. Stockholders exercise control through voting rights and receive a share of corporate profits through dividends. In the event the corporation is sold or liquidated, owners of common stock will share the net proceeds.
ADVANTAGES
1. Over the long run, common stocks have provided an average annual rate of return almost twice that of fixed income investments. Returns on stocks have averaged 9% to 10% over the past 50 years while fixed income securities such as corporate bonds and government securities have averaged only 4%. From 1996 through 2005, the Standard & Poor’s 500 Stock Index averaged a compound annual rate of return of 9.02%.
2. Common stocks are highly marketable. This means that they can quickly and easily be converted to cash if necessary. This liquidity itself enhances their value.
3. The huge number of common stocks available makes it possible for investors to select securities that are compatible with their own particular investment requirements and risk-taking preferences. For example, public utility stocks have traditionally been selected by investors with a preference for security and stable income while growth stocks may be more attractive to those who are willing to accept greater risk and do not need current income.
4. Unlike many real estate investments, common stocks do not require personal involvement in the day-to-day management of the enterprise. How much time the investor spends on managing his or her portfolio is another matter and depends on many variables including: personal preference and investment style; availability of time; and the degree of knowledge and skill of the investor.
DISADVANTAGES
1. The market price of stocks can fluctuate widely over time. Day-to-day changes in share prices are inevitable and beyond the investor’s control. Even over fairly long time periods, stock prices can decline. For example, the S&P 500 Stock Index fell by 9.1% in 2000 and declined another 11.9% in 2001, and by 22.1% in 2002. However, this was the first consecutive three-year decline since the late 1930’s. This volatility may be unsettling to conservative investors for whom preservation of capital is a high priority.
2. The prices of individual securities may be adversely affected by factors unrelated to the financial condition of the business itself. These may include political events, changes in tax laws or interest rates, and general economic conditions.
3. It is possible that an investor could lose all or a significant portion of his investment. For instance, if an individual were forced to sell shares during a depressed market, the result might be a permanent loss of capital.
4. Payment of dividends on common stock is not guaranteed. Although many corporations have traditionally paid regular dividends, declaration of a dividend, as well as the specific amount, is at the discretion of the corporation’s board of directors. Thus, dividends may vary with changes in the general financial condition of a company. This would be a potential problem for investors who desire a regular income.
TAX IMPLICATIONS
1. Dividends on common stock are generally taxed as ordinary income. However, under JGTRRA 2003, “qualified dividend income” (generally, dividends paid by domestic corporations and certain foreign corporations to shareholders) is treated as net capital gain and is, therefore, subject to lower tax rates. For taxpayers in the 25% income tax bracket and higher (28%, 33%, and 35%), the maximum rate on qualified dividends paid by corporations to individuals is 15% in 2003 through 2010. For taxpayers in the 15% and 10% income tax brackets, the tax rate on qualified dividend income is reduced to 5% in 2003 through 2007, and all the way down to 0% in 2008 through 2010. The preferential treatment of qualified dividends as net capital gains will “sunset” (expire) on December 31, 2010, after which time the prior treatment of dividends will, once again, be effective.[1.] In other words, dividends will once again be taxed at ordinary income tax rates.
2. Capital gains are taxable at various rates depending on the holding period of the investment. Short-term gains (12 months or less) are taxable at ordinary income tax rates up to a maximum of 35% (in 2006). Long-term gains (more than 12 months) are taxable at only a 5% rate for investors in the 10% or 15% brackets (in 2003 through 2007; 0% in 2008 through 2010), and 15% for investors in all other brackets in 2003 through 2010. On December 31, 2010, the lower capital gain rates (15%/0%) will “sunset” (i.e., expire), at which time the capital gain rates will return to pre-JGTRRA levels (i.e., 20%/10%).
3. Losses on the sale of common stock will be short-term or long-term depending on how long the stock was held (see “Capital gain” in the Glossary for the necessary holding period). Capital losses are deductible dollar-for-dollar against short-term capital gain, long-term capital gain, and finally, to a limited degree, against ordinary income. Assume Dick Goldman had a capital “paper loss” of $8,000 and an actual realized short-term gain of $5,000 in the same year. If he sold the depressed shares and recognized the $8,000 loss, $5,000 of the loss would be used to wipe out the entire short-term gain. This would leave a $3,000 loss that could be used to reduce his ordinary income. (The maximum amount of ordinary income that may be offset in one tax year is $3,000; any excess capital loss may be carried over to the succeeding tax year.) Qualified dividend income, which is treated as net capital gain under JGTRRA 2003, is not eligible to offset capital losses.
4. Year-to-year appreciation in share prices is not taxable unless and until the investor realizes the gain by selling the stock or otherwise disposing of it in a taxable transaction. This makes it possible to defer the gain until a tax year in which the investor is in a lower tax bracket. For example, Bob Norton might deliberately delay the sale of highly appreciated stock until after retirement when he will be in a lower tax bracket.
WHAT FEES OR OTHER ACQUISITION COSTS ARE INVOLVED?
When common stocks are purchased directly from a broker or a bank, there is a sales charge commonly called a brokerage commission or fee. The amount of the fee will be dependent upon the amount invested and the number of shares purchased.
Commission charges will vary widely and investors should compare the rates charged by various sources when buying or selling shares. However, transaction costs are not the only factor to consider in buying or selling shares of stock. The information, advice, and other services that are provided by a firm may easily justify a higher commission rate.
HOW DO I SELECT THE BEST OF ITS TYPE?
1. Professional security analysts rate common stocks according to their (1) overall quality, (2) security, and (3) growth potential. The process involves an analysis of various factors such as product and industry position, corporate resources, and financial policy. Among the rating services that can be found in your local library (or on the Internet) are Standard & Poor’s (www.standardandpoors.com), Moody’s (www.moodys.com), the Value Line Investment Survey (www.valueline.com), and Morningstar (www.morningstar.com). Standard & Poor’s and Moody’s issue quality ratings for common stocks. These rankings do not take into account the current price of a stock, which is a critical factor in making a particular purchase or sale. A highly rated stock may be overpriced while a stock with a low rating may be attractively priced and a good buy. Standard & Poor’s also publishes research that attempts to evaluate the prospects for a particular stock based on their proprietary research.
“The Value Line Investment Survey” contains a number of useful ratings. Each stock covered is rated for timeliness, safety, and technical analysis, and is also issued a financial strength rating, price stability score, growth persistence score and earnings predictability score. Conservative investors usually avoid those stocks rated “B” or lower by Standard & Poor’s or Moody’s or those with a Value Line safety ranking lower than “3.”
2. Extensive information and investment advisory services are offered by most brokerage firms. They can provide recommendations on specific industries or individual companies in the form of research reports by their own analysts. Brokerage firms also make available information that they in turn purchase from one or more professional research firms.
3. A wealth of information can be obtained at no cost by writing to the headquarters of a company and requesting a copy of its “annual report.” This report contains information on the company’s activities, its financial condition, products or services, general outlook, management personnel, dividend payments, and future prospects. A more detailed version of this report, known as a “10-K report,” can also be obtained by writing to the company or to the Securities and Exchange Commission, Washington, D.C. Free annual reports are provided by the Wall Street Journal on the Internet at: http://wsjie.ar.wilink.com/asp/WSJ3_search_eng.asp.
4. Investors seeking current income should examine the dividend payment record of the stock in question. The services listed above will indicate the current dividend being paid on the stock, if any, and the amounts paid in prior years. Brokerage firms can provide lists of companies that have paid dividends consistently for many years and those firms that have increased their dividends regularly. The Value Line Investment Survey ranks stocks according to their current dividend yield percentage. This ranking would enable an investor to quickly select those stocks providing the highest level of dividend income per dollar of investment.
For more Information:
Stock Trading & Equity Investment Center
Learn how to Invest, Buy Stocks, Sell Stocks, Investing. Discover Tools & Techniques on How To Beat The Stock Market.
WHAT IS IT?
Common stock represents an ownership interest in a corporation. Each shareholder is entitled to a proportionate share of the control, profits, and assets of the corporation. Stockholders exercise control through voting rights and receive a share of corporate profits through dividends. In the event the corporation is sold or liquidated, owners of common stock will share the net proceeds.
ADVANTAGES
1. Over the long run, common stocks have provided an average annual rate of return almost twice that of fixed income investments. Returns on stocks have averaged 9% to 10% over the past 50 years while fixed income securities such as corporate bonds and government securities have averaged only 4%. From 1996 through 2005, the Standard & Poor’s 500 Stock Index averaged a compound annual rate of return of 9.02%.
2. Common stocks are highly marketable. This means that they can quickly and easily be converted to cash if necessary. This liquidity itself enhances their value.
3. The huge number of common stocks available makes it possible for investors to select securities that are compatible with their own particular investment requirements and risk-taking preferences. For example, public utility stocks have traditionally been selected by investors with a preference for security and stable income while growth stocks may be more attractive to those who are willing to accept greater risk and do not need current income.
4. Unlike many real estate investments, common stocks do not require personal involvement in the day-to-day management of the enterprise. How much time the investor spends on managing his or her portfolio is another matter and depends on many variables including: personal preference and investment style; availability of time; and the degree of knowledge and skill of the investor.
DISADVANTAGES
1. The market price of stocks can fluctuate widely over time. Day-to-day changes in share prices are inevitable and beyond the investor’s control. Even over fairly long time periods, stock prices can decline. For example, the S&P 500 Stock Index fell by 9.1% in 2000 and declined another 11.9% in 2001, and by 22.1% in 2002. However, this was the first consecutive three-year decline since the late 1930’s. This volatility may be unsettling to conservative investors for whom preservation of capital is a high priority.
2. The prices of individual securities may be adversely affected by factors unrelated to the financial condition of the business itself. These may include political events, changes in tax laws or interest rates, and general economic conditions.
3. It is possible that an investor could lose all or a significant portion of his investment. For instance, if an individual were forced to sell shares during a depressed market, the result might be a permanent loss of capital.
4. Payment of dividends on common stock is not guaranteed. Although many corporations have traditionally paid regular dividends, declaration of a dividend, as well as the specific amount, is at the discretion of the corporation’s board of directors. Thus, dividends may vary with changes in the general financial condition of a company. This would be a potential problem for investors who desire a regular income.
TAX IMPLICATIONS
1. Dividends on common stock are generally taxed as ordinary income. However, under JGTRRA 2003, “qualified dividend income” (generally, dividends paid by domestic corporations and certain foreign corporations to shareholders) is treated as net capital gain and is, therefore, subject to lower tax rates. For taxpayers in the 25% income tax bracket and higher (28%, 33%, and 35%), the maximum rate on qualified dividends paid by corporations to individuals is 15% in 2003 through 2010. For taxpayers in the 15% and 10% income tax brackets, the tax rate on qualified dividend income is reduced to 5% in 2003 through 2007, and all the way down to 0% in 2008 through 2010. The preferential treatment of qualified dividends as net capital gains will “sunset” (expire) on December 31, 2010, after which time the prior treatment of dividends will, once again, be effective.[1.] In other words, dividends will once again be taxed at ordinary income tax rates.
2. Capital gains are taxable at various rates depending on the holding period of the investment. Short-term gains (12 months or less) are taxable at ordinary income tax rates up to a maximum of 35% (in 2006). Long-term gains (more than 12 months) are taxable at only a 5% rate for investors in the 10% or 15% brackets (in 2003 through 2007; 0% in 2008 through 2010), and 15% for investors in all other brackets in 2003 through 2010. On December 31, 2010, the lower capital gain rates (15%/0%) will “sunset” (i.e., expire), at which time the capital gain rates will return to pre-JGTRRA levels (i.e., 20%/10%).
3. Losses on the sale of common stock will be short-term or long-term depending on how long the stock was held (see “Capital gain” in the Glossary for the necessary holding period). Capital losses are deductible dollar-for-dollar against short-term capital gain, long-term capital gain, and finally, to a limited degree, against ordinary income. Assume Dick Goldman had a capital “paper loss” of $8,000 and an actual realized short-term gain of $5,000 in the same year. If he sold the depressed shares and recognized the $8,000 loss, $5,000 of the loss would be used to wipe out the entire short-term gain. This would leave a $3,000 loss that could be used to reduce his ordinary income. (The maximum amount of ordinary income that may be offset in one tax year is $3,000; any excess capital loss may be carried over to the succeeding tax year.) Qualified dividend income, which is treated as net capital gain under JGTRRA 2003, is not eligible to offset capital losses.
4. Year-to-year appreciation in share prices is not taxable unless and until the investor realizes the gain by selling the stock or otherwise disposing of it in a taxable transaction. This makes it possible to defer the gain until a tax year in which the investor is in a lower tax bracket. For example, Bob Norton might deliberately delay the sale of highly appreciated stock until after retirement when he will be in a lower tax bracket.
WHAT FEES OR OTHER ACQUISITION COSTS ARE INVOLVED?
When common stocks are purchased directly from a broker or a bank, there is a sales charge commonly called a brokerage commission or fee. The amount of the fee will be dependent upon the amount invested and the number of shares purchased.
Commission charges will vary widely and investors should compare the rates charged by various sources when buying or selling shares. However, transaction costs are not the only factor to consider in buying or selling shares of stock. The information, advice, and other services that are provided by a firm may easily justify a higher commission rate.
HOW DO I SELECT THE BEST OF ITS TYPE?
1. Professional security analysts rate common stocks according to their (1) overall quality, (2) security, and (3) growth potential. The process involves an analysis of various factors such as product and industry position, corporate resources, and financial policy. Among the rating services that can be found in your local library (or on the Internet) are Standard & Poor’s (www.standardandpoors.com), Moody’s (www.moodys.com), the Value Line Investment Survey (www.valueline.com), and Morningstar (www.morningstar.com). Standard & Poor’s and Moody’s issue quality ratings for common stocks. These rankings do not take into account the current price of a stock, which is a critical factor in making a particular purchase or sale. A highly rated stock may be overpriced while a stock with a low rating may be attractively priced and a good buy. Standard & Poor’s also publishes research that attempts to evaluate the prospects for a particular stock based on their proprietary research.
“The Value Line Investment Survey” contains a number of useful ratings. Each stock covered is rated for timeliness, safety, and technical analysis, and is also issued a financial strength rating, price stability score, growth persistence score and earnings predictability score. Conservative investors usually avoid those stocks rated “B” or lower by Standard & Poor’s or Moody’s or those with a Value Line safety ranking lower than “3.”
2. Extensive information and investment advisory services are offered by most brokerage firms. They can provide recommendations on specific industries or individual companies in the form of research reports by their own analysts. Brokerage firms also make available information that they in turn purchase from one or more professional research firms.
3. A wealth of information can be obtained at no cost by writing to the headquarters of a company and requesting a copy of its “annual report.” This report contains information on the company’s activities, its financial condition, products or services, general outlook, management personnel, dividend payments, and future prospects. A more detailed version of this report, known as a “10-K report,” can also be obtained by writing to the company or to the Securities and Exchange Commission, Washington, D.C. Free annual reports are provided by the Wall Street Journal on the Internet at: http://wsjie.ar.wilink.com/asp/WSJ3_search_eng.asp.
4. Investors seeking current income should examine the dividend payment record of the stock in question. The services listed above will indicate the current dividend being paid on the stock, if any, and the amounts paid in prior years. Brokerage firms can provide lists of companies that have paid dividends consistently for many years and those firms that have increased their dividends regularly. The Value Line Investment Survey ranks stocks according to their current dividend yield percentage. This ranking would enable an investor to quickly select those stocks providing the highest level of dividend income per dollar of investment.
For more Information:
Stock Trading & Equity Investment Center
Learn how to Invest, Buy Stocks, Sell Stocks, Investing. Discover Tools & Techniques on How To Beat The Stock Market.
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