What is a Common Stock Equivalent?

Malcolm Tatum

A common stock equivalent is another financial instrument that has the potential to be converted into common stock. There are several different types of instruments that possess this potential. However, the conversion of a common stock equivalent is not always desirable for the holder of the instrument or other investors.

A common stock equivalent is a financial instrument that has the potential to be converted into common stock.
A common stock equivalent is a financial instrument that has the potential to be converted into common stock.

Preferred stocks sometimes carry the possibility of conversion into common stock. This is usually the case when the company in question has issued both preferred stock and common stock. The terms and conditions that control the issue of preferred stock will specify if the stock can rightly be considered a common stock equivalent. It is important to note that not all forms of preferred stock are automatically eligible for conversion, even if the company does also issue common stock.

Another example of a common stock equivalent is the preferred bond. Once again, it is important to note that the terms and conditions connected with preferred bonds will vary from one situation to another. If the bond in question does have the ability to be converted into common stock, that ability will be noted in the information regarding the structure of the bond issue.

Warrants to purchase also can be regarded as an example of common stock equivalent. Essentially, warrants to purchase are documents that provide the holder with the right to purchase common stock at a specific price. Often, that price will be less than the current market value.

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One of the drawbacks to converting a common stock equivalent into common stock is that the transaction can create equity issues for existing stockholders. In some cases, the process will weaken the overall value of the stock, because the conversion reduces or dilutes the earnings per share that would be realized had the conversion not taken place. For this reason, it is not uncommon for investors to be wary of this type of action, and for some companies to specifically not allow for the conversion of preferred stock to common stock.

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