Common Stock Equivalent Definition
Common stock equivalent refers to a term used to describe the various type of securities that allow the holder to acquire common stock. These common stock equivalents may include securities such as warrants, stock options, grants bonds, preferred stock, and contingent shares.
The common stock equivalent happens when the security’s market price is performing above the exercise price.
A Little More on What is Common Stock Equivalent
Note that where the market price is at or above, the security can be converted into common stock. When the market price is below, there is a possibility of losing money when you convert the security to the common market. Due to this, it makes it not to be considered a common stock equivalent. However, the value of equivalents always changes based on the market value of the firm’s common stock.
Generally, when a person is investing in stock, he or she will either buy what is called ordinary share or common stock. The purchase of these shares is what gives a person a right to company ownership as well are the right to be paid dividends. Note that common stock exists in two classes.
These two classes have different dividend and voting rights. Preferred stock is also another type of stock. The holders of these particular stock have certain priorities over common stockholders. This is more especially when it comes to dividends payment and when the company happens to be under liquidation.
How Common Stock Equivalent Works [Example]
When firms want to come up with capital for their business, they will issue common stock. The purchase of common stock in the market gives an investor the following rights:
- Voting rights over certain corporate issues
- Share in the company’s ownership
- Receive dividends
Generally, the common stock equivalent will fall in any of the following categories:
- Convertible securities
This includes preferred bonds and stocks that a company issues for the purpose of providing conversion features to investors. The feature in the preferred stock adds value to the underlying security’s marketability, and that is why investors value it. Also, it gives investors an opportunity to enjoy the benefits that common stock generates without actually owning the security.
- Employee Stock Option Plans
This refers to a stock option that is both restricted and unrestricted, which also includes grants and warrants. The compensation plan gives employees an opportunity to buy shares, either at a discounted price or at no charges at all.
Generally, the moment a security fall under a common stock equivalent, it can be used to calculate per share primary earnings. Note that this only happens in case the securities become dilutive. However, some securities like the type of convertible bonds can be anti-dilutive. This is a great deal to an investor since it increases the earnings of every share.
How to Convert Stock Equivalents
The common stock equivalent can be compared to dilute securities, which dilutes the ownership of the existing shareholders. For this to happen, the company’s income statement must reflect base earnings per share and diluted earnings per share. This is especially if there is the availability of different forms of stock, such as securities resulting from common stock equivalent.
Note that there are various ways you can convert common stock equivalent. For instance, employee stock option plans can be used as a job incentive for employees. This allows employees to purchase securities at reduced rates. After a specified investing period has elapsed, the employees can then convert the securities to common stock.
Other Forms Converting Common Stock
There exist other forms of common stock equivalent. However, they have their own governing rules. This is as far as to when and how stocks are exchanged. A good example is converting bonds into shares.