Common Stock Vs. Preferred Stock

To raise funds, publicly listed corporations might sell preferred or common stock to investors.

Both can pay dividends, albeit the amount paid out and the timing of such payouts may differ.

Between the two, common stock is typically offered by more corporations than preferred stock.

Whether you should invest in preferred stock or common stock depends on your investment goals and whether you want to have voting rights as a shareholder.

What is Common Stock?

Common stock is a kind of ownership in a corporation that gives its holders the right to vote at shareholder meetings and earn dividends.

If the company goes bankrupt, common stockholders will receive a portion of the liquidation proceeds after all creditors and preferred stockholders have been settled.

When an investor owns common stock in a company that is having financial difficulties, this low degree of liquidation preference might result in money being lost.

But when a corporation is tremendously profitable, most of the benefits go to the common investors.

Common stock isn't just popular in the name; it's also the most popular among investors.

Common stockholders have a say in some policy and management decisions as well. A vote is normally assigned to each share.

In comparison to preferred stock, the value of a common stock is derived from its share price appreciation through time instead of dividends.

Common stock has a stronger long-term growth potential than preferred stock, but it has a lower priority for dividends and payouts in the case of a liquidation. Common stock, like preferred stock, has a higher possibility of going to zero.

Long-term investors may prefer common stock over other options.

PROs of Common Stock

• Voting privileges are granted.

• There is no limit to how high the stock price can rise.

• Capital gains taxes are withheld until the stock is sold.

CONs of Common Stock

• Price volatility is high.

• There is the possibility of you not earning any dividends.

• Preferred shares receive dividends first, followed by common shares.

• In the event of a liquidation, common shares have a lower priority than preferred shares in terms of receiving a dividend.

What is Preferred Stock?

Preferred stock is a type of equity ownership that has a higher priority claim on a company's earnings and assets than regular stock.

Preferred stockholders must be settled before common stockholders, but after secured debt holders, in the case of a liquidation.

Preferred stock also pays a dividend; this payment is normally cumulative, so any missed earlier payments must be completed before common stock distributions can be issued.

Irrespective of its name, most investors don't necessarily choose preferred stock, even if it does have its advantages.

Preferred stock is similar to a bond in many ways. A preferred stock's dividend, for example, is usually its primary source of income.

Also, they are more likely than common shares to pay out a higher yield. Preferred stock, like bonds, appears to be better when interest rates drop.

This type of stock also has a par value, which is the price at which it is issued, and may usually be redeemed when the preferred shares grow.

Preferred stock can be "called" (a call means that it can be redeemed by the firm) at a future date.

As a result, the call price could very well be higher than the price paid by the investor.

Another distinct characteristic of some kinds of preferred stock is that they can be changed into a certain number of common shares. However, the opposite is not possible. Convertible preferred stock is the name for this sort of stock.

Short-term investors who are unable to keep ordinary stock for long enough to withstand price drops may find preferred stock to be a good option.

It is so because the preferred stock has lower volatility than common stock, but it also has lower long-term growth potential.

PROs of Preferred Stock

• Receives a dividend that is generally higher than that of common shares.

• There's a lower danger of losing money.

• Has precedence over common stock in terms of payout in the event of bankruptcy and dividend payments.

CONs of Preferred Stock

• The price of a share can only rise so far before it reaches the redemption value.

• The right to vote is frequently denied.

Common Stock Vs. Preferred Stock

There are several contrasts between preferred and common stock.

1. The first contrast is that only holders of common stock have voting rights as shareholders.

These voting rights allow shareholders to vote for corporate directors, issue more shares, and accept a takeover bid, among other things.

Preferred shareholders have no say in the company's future, whereas common shareholders do.

2. The second contrast is that preferred stock typically provides a fixed rate of return to owners, whereas common stockholders may or may not get any dividend.

Preferred stock is structured similarly to a bond, with a fixed percentage distribution based on the face value of each unit. However, the firm is not required to purchase back the shares. On the other hand, the specified dividend will be paid in continuity.

Holders of common stock, on the other hand, only receive dividends if the board of directors permits it, which it may likely not do if the company's cash flows do not justify it.

3. The third contrast is that, based on the preferred stock's features, common stock typically exceeds preferred stock returns.

Why this is so is because, if the company does well, the gains flow to common shareholders, while preferred shareholders' returns are restricted to fixed dividend payments.

But when the company is performing poorly, the price of its common stock will significantly underperform the market.

4. The fourth contrast is that some varieties of preferred stock contain a call feature, which allows the issuing company to redeem them from investors after a specified time has passed, usually at a significant premium that is above the initial price.

A call functionality is not available in common stock.

5. The fifth distinction is that preferred stockholders have a greater priority for a share of corporate funds than common stockholders.

If the corporation has not yet paid out preferred dividends, for instance, the preferred shareholders are expected to claim their dividend payments before the common shareholders.

Preferred shareholders will also be compensated before common shareholders in the case of business liquidation.

Conclusion 

If you should invest in preferred stock or common stock depends on your needs. Preferred stock may be a perfect choice if you seek a steady stream of dividend income.

Dividends could be greater than those paid by common stocks, and you may be capable of converting your shares based on the stock.

If you're more interested in long-term earnings than dividends, common stocks may be a better option.

Looking at both of them, one isn't always better than the other when it comes to preferred stock and common stock. Both have their benefits and drawbacks.

Investing in a combination of each, as well as other types of assets, can help you diversify your investment portfolio and manage risk and return.