Ordinary shares, also known as common shares, are a fundamental element of the equity capital structure of publicly traded corporations. These shares represent fractional ownership in a company and come with specific rights and obligations for their holders. In this article, we will explore what ordinary shares are, their characteristics, comparison with preferred shares, the rights of shareholders, and their value in the stock market.
What Are Ordinary Shares?
Ordinary shares are stocks that are traded on public exchanges, such as the New York Stock Exchange (NYSE) and the NASDAQ. Each share typically provides its owner with one vote at the company’s annual general meetings (AGMs), allowing shareholders to influence key decisions regarding corporate governance and strategic direction. Unlike preferred shares, which guarantee a fixed dividend payment, ordinary shares do not promise a dividend, making their returns more dependent on the company's performance.
Key Features
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Voting Rights: Ordinary shareholders generally possess voting rights, enabling them to participate in significant corporate decisions, including the election of board members and approval of major transactions such as mergers or acquisitions.
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Dividends: While ordinary shareholders may receive dividends, these are not guaranteed. Dividend payments are determined by a company’s board of directors based on its financial performance, profits, and retained earnings.
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Profit Sharing: Shareholders are entitled to share in the profits of the company. If the company is profitable and dividends are paid, ordinary shareholders receive their proportion of the earnings after preferred shareholders are compensated.
The Rights of Ordinary Shareholders
Ordinary shareholders enjoy specific rights that are enshrined in corporate law:
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Voting Rights: Shareholders typically have the right to vote on crucial matters affecting the company.
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Right to Dividends: Shareholders are entitled to a portion of the profits, but only after all preferred dividends have been paid.
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Right to Information: Ordinary shareholders have access to the company’s financial statements and annual reports, ensuring transparency.
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Right to Residual Assets: In the event of liquidation, ordinary shareholders are entitled to the remaining assets of the company after all debts and preferred stocks have been paid off. This can be a precarious position since they are last in line during bankruptcy proceedings, trailing behind creditors and preferred shareholders.
Advantages and Disadvantages of Ordinary Shares
Advantages
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Higher Profit Potential: Ordinary shareholders can potentially see higher returns, especially if the company grows and generates significant profits. Unlike preferred shareholders, who receive fixed dividends, ordinary shareholders can benefit from increasing dividends and stock price appreciation.
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Participation in Corporate Decisions: With voting rights, ordinary shareholders have a say in key issues, influencing a company’s direction and governance.
Disadvantages
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Higher Risk: Ordinary shares come with greater risk compared to preferred shares. There is no guarantee of dividends, and in the event of financial distress, ordinary shareholders stand last in the queue for compensation.
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Volatility: The price of ordinary shares tends to be more volatile in the market compared to preferred shares, reflecting investor sentiment, market conditions, and the company's performance.
How Ordinary Shares Are Valued
The market value of ordinary shares is predominantly dictated by supply and demand dynamics in the stock market. Although they may have a par value (often a nominal amount), the price at which shares are bought and sold can differ significantly based on various factors, including:
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Company Performance: Earnings reports, growth prospects, and market outlook heavily influence stock prices.
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Market Conditions: Broader market trends, economic indicators, and investor sentiment can also impact the value of ordinary shares.
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Comparative Analysis: Investors often compare a company’s financial ratios (P/E ratio, dividend yield, etc.) to its peers to gauge relative value.
A prominent example of ordinary share valuation is Berkshire Hathaway Inc. (BRK.A). Despite having a par value of $5, the shares traded for over $325,000 per share as of early September 2020, highlighting how market forces can significantly elevate the price of ordinary shares.
Conclusion
Ordinary shares play a vital role in the capital structure of companies and provide a means for individuals to invest directly in entrepreneurial ventures and participate in corporate governance. Understanding the implications of owning ordinary shares is essential for investors looking to navigate the complexities of the stock market. With their inherent risks and rewards, ordinary shares can be a powerful tool for building wealth, especially for those who are willing to engage with the dynamics of the companies they invest in.