Common stocks and treasury stocks are important components of the equity of a company. Although both represent equity, they work in contrasting ways.
Let us discuss what are common stocks and treasury stocks and their key differences.
What is Common Stock?
Common stock or a common share refers to a type of security that represents the ownership of the holder in a company.
Common stock represents equity ownership of a company. It gives the holder the ownership rights in a company. It is also known as common shares, ordinary shares, voting shares, etc.
Common stock is the legal status of ownership in a company. For private companies, there is a limited number of owners that own the company.
For public companies, there is a large number of shares issued to the general public. Each shareholder gets the ownership rights in the proportion of their purchased shares.
Common shareholders of a company include the general public, institutional investors, company employees, managers, and founders of the company.
The executive suite or the board of directors are also common stockholders of a company. However, they are often offered preferred shares as well.
How Do Common Stocks Work?
Companies go public to raise equity capital from the market primarily. There are added advantages of going public as well.
A company may ask an investment bank for underwriting an initial public offering (IPO) and help the company to decide the price and number of shares to be issued on the IPO day.
An IPO is the process of issuing new stock (often for the first time) to the general public through a listing on a stock exchange.
Once the company completes its IPO, the general public can trade its shares on the stock exchange. Investors become shareholders of the company.
Common stockholders hold voting rights as well. However, some companies may issue two types of shares with voting and non-voting rights.
From an investor’s perspective, common stocks represent a risky investment. The return on investment depends directly on the company’s performance and hence the share price.
From the company’s perspective, equity offers easier access to the capital market. Also, it helps a company manage its gearing level and obtain more debt.
What is Treasury Stock?
Treasury stocks are shares or stocks repurchased by a company from its shareholders. These shares can be repurchased from individual or corporate investors.
Once a company repurchases stocks, they are held at its disposition. There are a few options for the company about treasury stocks.
Until the company holds treasury stocks, they are reported on the financial statements of the company like other equity components.
Treasury stocks are the stocks repurchased through a buy-back program that was initially issued by the company. A company has a specific number of issued and outstanding shares after initially getting approval for the authorized shares.
How Do Treasury Stocks Work?
A company gets approval for issuing a fixed number of shares at once. Legally, a company can issue shares up to this number. However, if a company wants to issue more shares it can get approval again.
For several reasons, a company may decide to repurchase its outstanding shares in the market. When a company repurchases its shares, these shares no longer trade on a stock exchange.
These repurchased shares are held by the company as treasury stocks.
A company takes a few different routes with treasury stocks. These stocks can be held for reissue in the future.
More often companies retire treasury stocks permanently which reduces the total number of shares of the company permanently.
Most commonly a company repurchases its shares when it wants to control its share prices. Along with it, the company would be able to control other key metrics like EPS, DPS, Gearing ratio, and so on.
Other reasons for repurchasing stocks may include controlling the undervaluation of a company’s share price. A reduced number of shares in the market can boost share price and bring it to the right valuation level.
Many companies also repurchase shares for retiring issued shares permanently.
Unlike common stocks, treasury stocks do not hold voting rights. These stocks are also not included in the net asset value of the company.
Common Stock Vs Treasury Stock – Key Differences
Common stocks and treasury stocks have contrasting characteristics. A company may use its issued shares as common stocks then repurchase them and hold them as treasury stocks.
Treasury stocks may become common stocks again if reissued. However, there are certain differences between these two types of stocks.
Ownership and Voting Rights
Common stocks represent the ownership of a company. These stocks represent legal ownership of the company.
Common stocks also come with voting rights. However, some companies may restrict voting rights by issuing shares with voting and non-voting rights.
Treasury stocks are held by a company. These stocks no longer trade on a stock exchange or are owned by shareholders. Therefore, these stocks do not represent ownership rights.
Also, as these stocks are held at the discretion of the company, they do not offer voting rights.
Monetary Value
Common stocks hold monetary value. In fact, common stocks derive the monetary value of the company.
Publicly listed companies hold their market capitalization through common stocks. As the share prices change, the market capitalization of the company changes.
A company’s common stocks have a base value (issue price) and a premium value. The base or issue price of common stock is fixed while its market share price changes.
Treasury stocks are repurchased by the company at the market share prices. As long as the company holds these stocks, these stocks also carry a monetary value.
Once a company retires treasury stocks, they do not represent any monetary value.
Cash Flow for the Company
Common stocks offer a cash inflow for the company. In practice, a company issues common stocks to raise capital from the market.
The cash flow value depends on the issue price and market share price set by the company in the IPO. Share prices change soon after the IPO as investors trade them on the stock exchanges. However, trading shares does not change the cash flow for the company.
Treasury stocks represent a cash outflow for the company. The company needs to spend money to repurchase outstanding shares.
If treasury stocks are purchased from corporate investors, they can be purchased at a predetermined fixed price.
Impact on Shareholders
Common stocks offer ownership status, voting rights, and monetary value to shareholders.
Many shares offer dividends that remain a consistent source of income for the shareholders as well.
Common stocks offer the highest level of ownership stakes. However, in the case of liquidation, common stockholders are the lowest level of priority legally.
Treasury stocks reduce the ownership proportion of the shareholders as the stakes shift from the shareholders to the company.
Also, treasury stocks do not offer dividend income, voting rights, or monetary value to shareholders.
Impact on the Company
Common stocks help a company raise money from the market. Public companies are represented through common and preferred stocks.
Commons stocks also offer financial stability by helping a company in managing its leverage and gearing ratios. Common stocks are the most prominent part of the total equity of the company.
On the other hand, treasury stocks help a company reduce its number of outstanding shares. They bring the share prices under control resulting in controlled financial ratios like EPS, DPS, gearing, and so on.
Profit Distribution and Dividends
Common stockholders receive profit distributions in the form of dividends. Each shareholder receives dividend income in the proportion of the shareholding.
Common stockholders also accumulate profits in the form of capital gains. However, dividends are not an obligation for all companies.
Treasury stocks do not receive dividends. These stocks are often retired permanently by the company. Therefore, these stocks are not included in the profit distributions as well.
Issuing Common Stock
Common stocks are issued through an initial public offering (IPO) for the first time. Then, these shares can be issued directly through a rights issue as well.
Stock splits also increase the number of outstanding shares of a company without issuing new shares.
Bonus shares and scrip shares are also common methods of issuing new shares by a company.
Retiring Stocks and Treasury Stocks
Repurchased shares represent treasury stocks. More often, these stocks are retired by the company.
Therefore, treasury stocks work exactly in the opposite way of common stocks. These stocks reduce outstanding shares meaning they reduce the ownership stakes of the shareholders.
However, disposing of treasury stocks is not an obligation for the company but an option. A company can hold and reissue treasury stocks whenever needed.
