What is the Difference Between Preferred Stock and Common Stock?

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When investors think of acquiring shares in a company, they usually come across two major types of stock: preferred stock and common stock. Each type of stock has been known to offer the investor varying features, benefits, and risks. The number one distinction between preferred stock and common stock lies in how they provide different rights and benefits to the shareholders, including dividend distribution, voting rights, and claims in the event of liquidation. Understanding these differences is fundamentally essential for any investor to make informed portfolio decisions.

Preferred Stock vs Common Stock: Key Differences

The difference between preferred and common stock relates to how each type of stock operates by rights such as ownership and its dividend and voting powers, including liquidation priority. Preferred stock offers fixed dividends and superior priority in case the firm goes into liquidation. However, it does not usually afford voting powers. On the other hand, common stock offers voting rights and a share in company growth. However, dividends are not guaranteed, and shareholders have lower priority during liquidation.

The key differences between preferred stock and common stock can be outlined in the following table:

Feature	Preferred Stock	Common Stock
Dividend Payment	Fixed and paid before common stock	Paid after preferred stock, and variable
Voting Rights	No voting rights	Voting rights on company decisions
Risk Level	Lower risk due to fixed dividends	Higher risk due to variable dividends and no guaranteed return
Priority in Liquidation	Higher priority in bankruptcy	Lower priority, paid after debts and preferred stockholders
Price Volatility	Less volatile, more stable	More volatile due to market conditions
Growth Potential	Limited growth potential	Higher potential for capital gains
Conversion Option	Convertible into common stock (in some cases)	Cannot be converted into preferred stock
Types of Shares	Often non-voting, sometimes convertible	Standard, with voting rights

The understanding of these differences ensures that the investor invests in the kind of stock he or she wants, whether preferred stock, which is relatively stable, or common stock, which holds great involvement in a company’s growth.

Preferred Stock Meaning

Preferred stock is a form of equity that comes with a preference claim on the assets and earnings of the company. This implies that preferred stockholders receive dividends ahead of common stockholders. Dividends are usually fixed, which provides a predictable income stream. In a liquidation of the company, preferred stockholders also collect their money prior to common stockholders, although after creditors and bondholders.

Despite such advantages, voting rights are not provided in preferred stocks in general. This can be a significant drawback for investors who expect to have a voice in how the company is run. The price volatility in the case of preferred stock is not as acute as that of common stock.

It appeals to conservative investors for a stable income and can be considered a hybrid between debt and equity. Preferred stock is a combination of features from both bonds, which carry a fixed income, and common stock, which is an equity ownership.

Types of Preferred Stock

There are several types of preferred stock, each offering different features and benefits. These types of preferred stocks include:

Cumulative Preferred Stock: When a firm skips a dividend, it has to pay those skipped dividends to cumulative preferred stockholders before any dividends can be paid to common stockholders.
Non-Cumulative Preferred Stock: Skipped dividends cannot be claimed in the future if the company fails to pay them.
Convertible Preferred Stock: It is convertible in the sense that the shareholder can convert preferred shares into common stock at a predetermined rate.
Participating Preferred Stock: Shareholders are entitled to extra dividends if the company does exceptionally well, besides their fixed dividends.
Redeemable Preferred Stock: The issuing company has the right to repurchase the stock at a predetermined price after a particular date.
Adjustable-Rate Preferred Stock: The stocks offer dividend rates, which are periodically changed in terms of an associated benchmark or index.
Perpetual Preferred Stock: These have no maturity date and, hence, pay dividends forever, provided the issuing company is solvent.

Each of these variations caters to different investor needs, offering flexibility, income stability, and protection depending on the circumstances.

Common Stock Meaning

Common stock represents ownership in a company. Shareholders holding common stock can vote on matters to be decided by the company, such as voting on a board of directors or significant business decisions, and may also receive dividends. However, these dividends aren’t promised, and the payouts may vary with the performance of the company.

The value of common stock is directly tied to the performance of the company. This means the stock price rises as the company grows and becomes more profitable, with the potential for capital gains for common stockholders. However, it is riskier. When liquidating, common stockholders are last in line in terms of getting payment; creditors come first, then bondholders and preferred stockholders.

Ownership Rights and Voting Power

One of the fundamental differences between common stock and preferred stock is the ownership rights and voting power attached to common stock. Common stockholders generally hold the right to vote at shareholder meetings. Thus, this automatically gives them a direct role in shaping the future of the company.

Dividend Payments

Unlike preferred stock, common stock dividends are not fixed and may fluctuate depending on the profits of the company. A corporation can pay more significant dividends to common stockholders if it does very well or invests its profits back into the business to create more growth. Preferred stockholders are guaranteed a set return, so preferred stock is a more stable investment for an income-oriented investor.

Difference Between Common Stocks and Uncommon Profits

Common stock refers to regular equity shares that people buy in a public company, while uncommon profits relate to possible extraordinary financial gains derived from exceptional business strategies, innovation, or growth. It differs from the average performance expected from common stock.

Common stocks can make returns that could be substantial, however, those returns are susceptible to market fluctuations, company performance, and broader economic considerations. Uncommon profit is often seen with companies that somehow disrupt industries or create new markets, leading to explosive growth that is far beyond the basic returns of common stock. Companies such as Apple or Amazon come to mind in terms of uncommon profits, where the particular combinations of innovative breakthrough products and services caused their stock prices to explode.

While common stock represents a share of a company’s overall performance, uncommon profits reflect exceptional returns that are driven by innovation or dominance over the market. Focusing on common stock often leads an investor to steady long-term growth, whereas uncommon profits seek high-risk, high-reward opportunities.

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Preferred Stock and Common Stock FAQs

What is the main difference between preferred stock and common stock?

The main difference between preferred stock and common stock lies in dividend payments and priority in liquidation. Preferred stock offers fixed dividends and higher priority in case of liquidation but does not grant voting rights. Common stock, however, comes with voting rights but has variable dividends and a lower claim on assets during liquidation.

Which stock is better: preferred or common stock?

The choice between preferred stock and common stock depends on your investment goals. If you seek stable income and lower risk, preferred stock may be a better option. If you want potential for capital gains and greater involvement in company decisions, common stock might be more suitable.

Can I convert preferred stock into common stock?

Yes, some types of preferred stock are convertible into common stock. This depends on the terms specified by the issuing company, such as the conversion rate and the time frame for conversion.

What are the advantages of common stock over preferred stock?

Common stock provides voting rights and potential for significant capital gains. It allows investors to participate in the company’s decision-making process and benefit from company growth, though it comes with higher risk due to the unpredictability of dividends.

Does preferred stock offer dividends?

Yes, preferred stock typically offers fixed dividends, which are paid before any dividends to common stockholders. This makes preferred stock an attractive option for investors seeking a steady income stream.