If you’re an investor considering choosing between common and preferred stock, then it’s important you know the different features of each so you can make an informed buying decision. When a company needs to raise money from investors, one way they achieve this is by selling stocks. A stock describes the ownership certificates of a company.
Stocks can be divided into two namely, common and preferred stocks. While both types show investment in a public company, they are not without their differences. In this article, I’m going to let you into the difference between common and preferred stock.
What Are Common Stocks?
“Common stock is a security that reflects the ownership of a company. Common stock holders elect the board of directors and vote on corporate policies. Typically, this form of equity ownership yields higher long-term return rates. However, in the case of liquidation, common shareholders are entitled to the assets of a corporation only after complete payment is made to bondholders, preferred shareholders and other debtholders. Common stock is listed in the stockholder ‘s equity section of the balance sheet of a company.”
Going by the definition above, we can deduce the following features of common stocks, which differentiate between common stocks and the preferred stock:
- There is partial ownership of the company.
- Holders of common stocks have voting rights.
- The ROI is relatively higher. Holders of these stocks tend to gain considerable profits through capital gain.
- There is the lowest priority for these holders in the event of a liquidation.
Also, another perk of being a common stockholder is the right to receive dividends whenever they are declared. Dividends are declared and shared by a company’s board of directors. This payment of profits and retained earnings is what is known as dividends. For a common stockholder, they only receive a percentage equal to their ownership in the company.
What Are Preferred Stocks?
Preferred stocks are otherwise known as preferred or preference shares. They are securities that represent ownership in a company. One of the many perks of being a preferred stockholder is that, unlike common shareholders, the preferred shareholder has a priority claim on the company’s assets and earnings. In other words, holders of preferred stocks are prioritized in terms of assets sharing or dividends payment.
Some features that differentiate preferred stocks from common stocks are as follows:
- Preference in dividends payment. The shares provide payment of dividends to shareholders. The preference, though, does not give any assurance of the payment of the dividend, the company must prioritize the payment of the stated dividends on the preferred stock over the common stock.
- Preference in assets during liquidation. These securities offer their holders the priority to claim the company assets over the common stockholders.
- Availability of dividends to stockholders. The securities provide dividends payments to the shareholders.
- Convertibility to common stocks. The share allows shareholders the right to exchange the shares for a predetermined number of the company’s common stock shares.
- Absence of voting rights. Except for extraordinary events, the shares don’t assign voting rights to the shareholders.
- Callability. This means the share can be redeemed before it matures. This can be done at the option of the company.
Which Is Better: Common or Preferred Stock?
There is no one-size-fits-all in deciding which is better between preferred and common stock. It all depends on what you’re looking for. If you’re to consider volatility, for example, you may want to opt for preferred stock. But on the profitability potential, common stock has higher profit potential.
Again, if you’re to choose based on the availability of voting rights, common stock is your best choice. While preferred stock doesn’t assign the voting right to the shareholders, there is a preference in dividends payment and claim to the company’s asset.
All in all, both have their pros and cons. So before you conclude on which type of stock investment may be suitable for you, try to take into consideration factors such as your goals for investing, financial status, and time frame.
Common Shares and Preferred Shares as an Investment
Common shares are far more available in terms of availability than preferred shares. Whether or not to purchase common shares vs. preferred shares is ultimately the investor’s goal. Many of those who buy common shares are generally interested in the opportunity for higher profits, but with higher risk.
In comparison, those who purchase preferred shares are typically interested in lower-risk regular dividend income. Also, investors in an environment with rising interest rates that lower the par value of the shares could not select preferred stock.
Now that you’ve understood the difference between common stock and preferred stock, determining which one will be right for you shouldn’t be a herculean task. However, before taking the plunge, you should consider your financial situations, goals, and time frame, among many other things. By comparing the two types of stock side by side, there is surely what will interest you in giving preference to one over another. So go ahead and take your time to understand the difference between the two types of stock and make an informed buying decision.