Capital Stock: Definition, Examples, Preferred vs. Common

The term “capital stock” refers to the total number of common and preferred shares that a company is permitted to issue. This figure is recorded in the shareholders’ equity section of the company’s financial statements.

Common stock represents ownership in a company and entitles shareholders to vote on certain matters, such as the election of the board of directors. Preferred stock, on the other hand, typically does not carry voting rights but does have priority over common stock when it comes to dividends and liquidation proceeds.

The amount of capital stock a company authorizes can vary depending on a number of factors, including the size of the company, its growth prospects, and its financing needs. For example, a small startup may only authorize a few thousand shares of common stock, while a large multinational corporation may authorize millions of shares of both common and preferred stock.

It’s important to note that just because a company authorizes a certain amount of capital stock doesn’t mean it has actually issued all of those shares. In fact, many companies only issue a portion of their authorized shares at any given time.

When a company does issue new shares of stock, it typically does so through a process known as a “stock offering.” This can take several different forms, including an initial public offering (IPO), a secondary offering, or a private placement.

In an IPO, a company offers shares of its stock to the public for the first time. This is typically done when a company is looking to raise capital to fund growth initiatives or pay down debt. The process involves working with investment banks to underwrite the offering and market the shares to potential investors.

A secondary offering, on the other hand, involves the sale of additional shares of stock by a company that has already gone public. This can be done for similar reasons as an IPO, such as raising capital for expansion or acquisitions.

Finally, a private placement involves the sale of shares of stock to a select group of investors, such as institutional investors or high net worth individuals. This type of offering is typically less expensive and less time-consuming than an IPO or secondary offering, but it also limits the pool of potential investors.

Regardless of how a company issues new shares of stock, it’s important for investors to understand the potential impact on their ownership stake. When a company issues new shares, it dilutes the ownership percentage of existing shareholders. For example, if a company has 1,000 shares outstanding and a shareholder owns 100 of those shares, they own 10% of the company. However, if the company issues an additional 500 shares, the shareholder’s ownership percentage would drop to 5%.

In addition to the impact on ownership percentage, issuing new shares of stock can also impact a company’s earnings per share (EPS). When a company issues new shares, it increases the total number of shares outstanding, which can dilute earnings per share. For example, if a company has earnings of $1 per share and 1,000 shares outstanding, its EPS would be $1. However, if the company issues an additional 500 shares, its earnings would still be $1, but it would now have 1,500 shares outstanding, resulting in an EPS of $0.67.

Overall, capital stock is an important concept for investors to understand when analyzing a company’s financial statements. By understanding how much stock a company has authorized and how it plans to issue new shares in the future, investors can better assess the potential impact on their ownership stake and earnings per share.