Area of Law: Investments and Securities
Answer # 281
StocksRegion: Ontario Answer # 281
Stocks, shares, and equities are all words that are used to describe investments that represent an ownership interest in a company. One share usually represents a very small percentage ownership in a company. Companies typically sell shares to raise money. If you invest in shares, your investment is tied to the fortunes of the company. If the company prospers, the company’s share price may increase. If the company is unsuccessful, the company’s share price may decrease.
There are several types of shares that a company can issue, and each type has different benefits and risks associated with it. The two main types of shares are common shares and preferred shares.
Difference between common and preferred shares
Both common and preferred shares represent investments in a company. The main difference between common and preferred shares is that preferred shareholders receive a fixed dividend as long as the company declares a dividend, whereas common shareholders may receive a dividend, depending on the performance of the company over a particular period. Dividends are payments that a company makes to its shareholders from its profit. The main disadvantage of both common and preferred shares is that if the business fails, investors could lose their entire investment, which is the price paid for the shares and any gain in the share’s value over time.
The advantage of preferred shares is that they provide greater security of a return than common shares. Preferred shareholders are paid dividends in priority to common shareholders, therefore, the dividend is typically fixed so that shareholders know what they will receive, and in the case of liquidation, preferred shareholders have a claim on the assets of the company in priority to the common shareholders. For example, if the business fails and the assets of the business are sold, then the proceeds are distributed to creditors and preferred shareholders before the common shareholders.
The disadvantage of preferred shares is that even if the company experiences tremendous growth and the company’s share price increases, the preferred shareholders do not share in the additional growth because their dividends are fixed and they typically only have the right to a return of capital invested. Also, there is no guarantee that dividends will be paid in any particular year. The decision as to whether to pay dividends rests with the directors of the company.
There are many types of preferred shares, some of which have voting rights in certain cases and some of which do not.
The other main type of share is a common share. The advantage of common shares is that if the company does very well, then the shareholder could earn a larger return on the investment in the form of higher dividends and an increase in the price of the shares. Also, common shares usually grant the owner voting rights at the annual shareholders’ meeting. The disadvantage of common shares is the risk of not receiving any dividends if there is not enough profit.
Also, investors who own common shares are subordinate in priority to investors who own preferred shares or debt with respect to claims on the assets and dividends of the company. Common shareholders are entitled to a residual interest in the company’s assets after the holders of debt and preferred shares are paid.
In general, common shares offer the potential for larger returns than preferred shares, but they also come with more risk than preferred shares.
Blue Chip stocks
Stocks in large, stable corporations are known as Blue Chip stocks. Blue Chip stocks are considered less risky investments. The term Blue Chip stocks refers to shares that have a record of continuous dividend payments. They are typically very solid investments in secure, highly rated companies. As with other companies, even Blue Chip companies from time to time decide not to pay dividends for any particular year. Instead, the company may decide to reinvest its profit back into the company. If this happens, investors will not receive any dividend payments.
Dividend Tax Credit
One advantage of investments that pay dividends is that they receive preferential tax treatment. If you invest in the common or preferred shares of a Canadian corporation, the dividend income you receive will be eligible for the Dividend Tax Credit. Dividends from Canadian corporations are subject to less tax than both interest income and capital gains. This means that investing in dividend-paying Canadian stocks may reduce taxes and improve the after-tax yield of your investment.
An accountant, a tax lawyer, or an investment advisor can help you calculate the tax advantage of owning shares in Canadian corporations and can advise you on which investments are eligible for the dividend tax credit.
Whenever you buy shares, it is important to remember that there is no reward without some risk. There is no guarantee that you will make money with stocks, and there is always a possibility that you could lose money. You should evaluate how much risk you are willing to accept, and determine whether your investment matches the level of risk you are comfortable with.
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