Investors often buy stocks because they are interested in paying dividends, raising capital, or voting in a shareholder meeting. There are two main types of shares: preferred and common. Each offers unique benefits to shareholders. Depending on your personal investment goals, you may be more interested in one stock than the other.
Preferred stock vs common stock
Both common stock and preferred stock represent percentage ownership in a company, but you are entitled to different rights depending on where you invest. Both preferred and common shares can be sold or traded on an exchange.
A common stock is usually the first thing that comes to mind when discussing stocks. It provides voting rights to shareholders and the issuer can choose to pay dividends to shareholders. In general, investors buy shares of common stock because of its ability to appreciate in value over time if the business is successful.
For example, if a company issues both preferred and common stock and has an extremely profitable year, the value of that company’s common stock will skyrocket, while its preferred may increase slightly.
A preferred stock pays dividends to shareholders who place dividend payments on a regular schedule, but does not have the same voting rights or capital appreciation potential as common stock. Investors tend to buy shares of preferred stock for a steady income and to reduce financial risk should a company experience a loss.
Now that we have the basics, let’s see what makes preferred stock different from common stock—and what makes them the same.
What is preferred stock?
Preference shares pay a fixed dividend to shareholders, are preferred in the event of bankruptcy, and are less affected by market fluctuations than common shares.
Preference shares are typically purchased for consistent dividend payments, which offer less financial risk to shareholders than common shares. It is important to note that dividend payments are not guaranteed. When the enterprise is profitable enough to pay dividends, the priority will be given to the shareholders first, and then to the common shareholders if there is any money left.
The same is true in the case of default. For example, suppose a company goes bankrupt. “Debt holders are prepaid, meaning all bondholders’ interest payments must be paid upfront,” said Patrick Bobbins, vice president of financial advisors at Wealth Enhancement Group. “After that, preferred shares will be paid second, and then common stock if the board decides to pay dividends at the end.”
Preferred stock has the potential to increase in value over time, but not nearly as much as common stock. This is because the value of preferred stock is inversely proportional to the interest rate. If interest rates fall, the value of preferred stock will increase.
How do preference shares work?
Preferred stock works similarly to a bond—it pays a fixed-income payment, has a par value, is callable, and can be issued with a maturity date, typically spanning 30 years or longer. Unlike bonds, preferred stock dividends are not guaranteed, so the issuer can skip paying preferred stock dividends if the company isn’t profitable.
Denominations: Preference shares are issued at a fixed par value, also known as par. This is the amount a shareholder will receive if they buy back the issuer’s shares. This is typically around $25 and can go up to $1,000 for corporate securities, but these stocks are generally geared toward larger institutional investors.
Call date: The issuer of preference shares may redeem to shareholders the right to redeem preferred shares for a specified amount, as set forth in the prospectus, after a certain date—known as the call date. Usually the payment is at face value or a higher purchase price. This amount doesn’t have to be the original price you paid for the preferred stock.
Companies often call stocks when interest rates are low, so they can reissue a new preferred stock with a lower dividend payout to match current market rates. This prevents preferred stock from increasing in value as much as common stock could.
Dividend: A dividend is a fixed payment that a shareholder receives from the issuer, usually paid quarterly. The issuer’s claims are dependent on whether the preferred stock is cumulative or non-cumulative.
For cumulative preferred shares, the issuer must pay preferred stock dividends from any missed payments, including those from previous years, before payments are made to shareholders. Common. This structure is common in real estate investment trusts (REITs).
For non-cumulative preferred shares, the issuer is not obligated to pay any missed payments and is not subject to any penalty for missing these dividends. Bank stocks typically have a non-cumulative structure.
There are several other types of preferred stock. Here is a general overview of what they are and their individual differences.
Advantages and disadvantages of preferred shares
Bobbins said investors tend to favor preferred stocks because of their higher average, fixed-income payments than common stocks. Other benefits of owning preferred stock include lower investment risk compared to common stock.
On the other hand, there is a limit on how much an investment can appreciate due to its call feature. Issuers often call preferred bonds in a low-yield environment so that they can reissue a stock that pays a lower dividend. Unlike common shares, preferred shares do not have voting rights.
What is common stock?
Common stock represents an ownership stake in a business and provides investors with voting rights in the company, allowing them to vote on key business elements such as electing a board of directors.
These stocks are intended to provide a higher rate of return over the long term than preferred stock. The value of common shares is closely related to business performance. For example, if a business is extremely successful, the value of the company’s common stock will increase. Shareholders may choose to hold their shares in the hope of increasing their capital gains over the long term, or may decide to sell their shares for a profit.
On the other hand, if a company does poorly, the value of common stock can drop to $0. In the event of a bankruptcy, preferred stockholders get priority in receiving bankruptcy payments before common stockholders—if there are not enough funds left, common stockholders may lose their initial investment altogether.
Because a common stock is more volatile, it is considered a riskier investment than a preferred stock. However, common stocks also have the ability to accumulate capital appreciation over the long term, which can significantly increase investment value.
How common shares work
Common shares are issued by both private and public companies. In an initial public offering (IPO), a company sells shares owned by their company, including voting rights, to raise capital to fund their business ventures. . After an IPO, shares of common stock can be sold or traded on the public market on stock exchanges, through a broker, or directly from a company.
Voting right: Common shares give shareholders the right to vote in shareholder meetings. This allows shareholders to weigh in on decisions such as potential stock splits, mergers and acquisitions, dividend payments, and other topics affecting their shares.
But not all shareholder votes are equal—the number of votes you get depends on how many shares you own. Therefore, someone who owns a large percentage of the company’s shares has a greater influence on voting matters than someone who owns only one or two shares. If a shareholder is unable to attend the meeting in person, they can still vote by proxy by mailing their ballot or allowing a third-party proxy to vote on their behalf.
Dividend: Companies are not required to pay dividends to common stockholders. However, if a company chooses to pay a dividend, the common shareholders will not receive any payment until all preferred shareholders have received their payments. If a company cannot pay a dividend in a particular year, common stockholders will not receive the missed dividend.
Pros and cons of common shares
Many investors prefer common stock because of its potential to earn long-term capital gains if the company is successful. But if the company does not perform well, common stock is more vulnerable to financial loss.
In the event of a company bankruptcy, the common stockholders are the last to get paid – if the company has any money left after paying back its creditors, creditors, bondholders and preferred shareholders.
How to choose between the two
If you are considering investing in stocks, you should carefully consider the key elements of both common stock and preferred stock before purchasing.
Voting right: Common stock gives shareholders the opportunity to vote in a company’s shareholder meetings on the factors that affect their stock ownership. Preferred stockholders waive this right in exchange for consistent dividend payments.
Investment vision: Investors with a long-term investment horizon often favor common stock because of its ability to increase in value significantly over time if a company is successful. On the other hand, investors with short-term financial needs may be more inclined to own preferred stock because of its steady dividend income.
Take risks: Common stocks are considered a riskier investment because of their tendency to fluctuate in value. Also, if a company goes bankrupt, common stockholders will receive the final payout if they receive any.
Preference shares are less volatile and therefore carry a lower risk of capital loss. In the event of insolvency, preferred shareholders have a higher priority to receive payments than common shareholders.
After all, both preferred stock and common stock are investment securities that come with additional risks including investment risk, interest rate risk, and capital risk. You should carefully consider your long-term financial and investment goals before buying shares in a company.
