What it means
Ownership of a company is a queue, and the common shareholder stands at the back of it. Lenders get their interest, suppliers get their invoices, and preferred shareholders get their fixed dividend before anything reaches ordinary shares.
What is left, called the residual, belongs to the common shareholders. That position sounds unattractive until you notice it is uncapped.
A bondholder earning 6% earns 6% however well the company performs, while the common shareholder captures every dollar of growth in the residual. This asymmetry, limited claim in bad times and unlimited claim in good times, is the whole logic of equity investing.
Common shareholders also usually hold the votes. They elect directors, approve major transactions and can, in aggregate, replace management.
This is why control questions dominate funding negotiations: issuing new common shares raises money but dilutes both the economics and the votes of existing holders. The main figures that matter to a common shareholder are earnings per share, dividends per share and book value per share, all of which are calculated after preferred claims are stripped out.
Getting that stripping-out right is the most common technical error people make when reading a set of accounts. Earnings available to common shareholders is net income minus preferred dividends, not net income.
Different classes are a frequent variant. Many companies issue Class A and Class B common shares with identical economics but different voting weight, which lets founders keep control while raising outside capital.
From a financial reporting point of view both are common shares; from a governance point of view they are not remotely equivalent.
In practice
Real-world examples.
Example
An employee at a listed retailer holds 3,000 common shares from a share plan. When the board declares a dividend of $0.45 a share, she receives $1,350 before tax and can vote her holding at the annual meeting. Her preferred-share-holding colleagues receive their fixed dividend first but have no vote.
Example
A family-owned brewery raises $4,000,000 by issuing new common shares to an outside investor for a 25% stake. The founding family's economic interest falls from 100% to 75%, and the investor gains the right to appoint one director. The family negotiates a dual-class structure so its shares carry three votes each.
Example
A regional airline enters administration owing $180,000,000 to lenders against assets realising $150,000,000. The common shareholders receive nothing, because the shortfall means the queue stops before it reaches them. Their maximum loss was the amount they invested, which is the protection limited liability provides.
Formula
Calculation
Earnings per common share = (net income - preferred dividends) / weighted average common shares outstanding
Book value per common share = (total shareholders' equity - preferred equity) / common shares outstanding
A manufacturer reports net income of $120,000,000 for the year and pays $4,000,000 of preferred dividends. It has 40,000,000 common shares outstanding, total shareholders' equity of $860,000,000 and preferred equity of $60,000,000.
Earnings available to common shareholders = $120,000,000 - $4,000,000 = $116,000,000
Earnings per common share = $116,000,000 / 40,000,000 = $2.90
Common equity = $860,000,000 - $60,000,000 = $800,000,000
Book value per common share = $800,000,000 / 40,000,000 = $20.00
An investor comparing the $2.90 of earnings against a $20.00 book value sees a return on common equity of $2.90 / $20.00 = 14.5%.Case study
Seen in the real world.
Trellis Kitchenware is an illustrative, fictional homeware manufacturer that had raised money twice: once through a preferred share issue paying a fixed $4,000,000 a year, and once through ordinary equity. A junior analyst preparing a board pack calculated earnings per share by dividing net income of $120,000,000 straight across the 40,000,000 common shares and reported $3.00.
The correct figure was $2.90, because the $4,000,000 of preferred dividends belongs to the preferred holders before anything is attributable to common shareholders. On a fictional but realistic multiple of 15 times earnings, that ten cent error moved the implied share price by $1.50, which on 40,000,000 shares is $60,000,000 of implied value.
The illustrative lesson is simple. When a company has any preferred stock, every per-share number for common shareholders has to be calculated after the preferred claim is removed, and a board pack that skips that step will overstate the value of the ordinary shares.
Watch out
Common mistakes.
- Calculating earnings per share from net income without deducting preferred dividends first.
- Assuming common shareholders are entitled to a dividend, when dividends on ordinary shares are always discretionary.
- Treating book value per share as what the shares are worth, when it is an accounting figure that ignores brand, people and future profits.
Questions
People also ask.
What is the difference between a common shareholder and a preferred shareholder?
The preferred holder gets a fixed dividend and ranks ahead in a wind-up but usually has no vote, while the common holder ranks last, votes, and keeps all the upside.
Can a common shareholder lose more than they invested?
In a limited liability company no, because the maximum loss is the amount paid for the shares plus any amount still unpaid on them.
Why do companies issue non-voting common shares?
To raise capital without diluting control, which suits founder-led businesses but is often discounted by institutional investors who dislike weak governance rights.
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