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Common stock represents an ownership interest in a corporation, but to the typical investor a share of common stock is simply a piece of paper characterized by two features:

1. It entitles its owner to dividends, but only if the company has earnings out of which dividends can be paid, and only if management chooses to pay dividends rather than retaining and reinvesting all the earnings. Whereas a bond contains a promise to pay interest, common stock provides no such promise—if you own a stock, you may expect a dividend, but your expectations may not in fact be met. To illustrate, Long Island Lighting Company (LILCO) had paid dividends on its common stock for more than 50 years, and people expected those dividends to continue. However, when the company encountered severe problems a few years ago, it stopped paying dividends. Note, though, that LILCO continued to pay interest on its bonds; if it had not, then it would have been declared bankrupt, and the bondholders could potentially have taken over the company.

2. Stock can be sold at some future date, hopefully at a price greater than the purchase price. If the stock is actually sold at a price above its purchase price, the investor will receive a capital gain. Generally, at the time people buy common stocks, they do expect to receive capital gains; otherwise, they would not purchase the stocks. However, after the fact, one can end up with capital losses rather than capital gains. LILCO’s stock price dropped from $17.50 to $3.75 in one year, so the expected capital gain on that stock turned out to be a huge actual capital loss.

Taken From : Five-Minute MBA – Corporate Finance

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