| Common Stock vs. Preferred Stock | ||
|---|---|---|
| Common Stock | Preferred Stock | |
| Voting Rights | Holders have voting rights in the company and can participate in decisions about corporate policies and the election of the board of directors. | Generally, holders do not have voting rights, although this can vary depending on the specific share terms. |
| Dividends | Not guaranteed and are paid out at the board of directors' discretion. | Usually fixed it must be paid before any dividends are given to common stockholders. |
| Liquidation Preference | Holders are last in line to claim any remaining assets, following bondholders and preferred stockholders. | Holders have a higher claim on assets and are paid out before common stockholders. |
| Convertibility | Cannot be converted into other forms of security. | May be converted to common shares based on terms. |
| Volatilability | Generally, more since it is more alert to company performance and market conditions. | Less, due to fixed dividends and a greater claim on assets. |
| Market Participation | Holders benefit directly from increases in the company's value. | Typically, do not participate in the company's growth beyond the fixed dividends. |
Voting Rights
Shareholders in a company have the right to vote on important decisions regarding the company's management. For example, shareholders vote on the members of the board of directors. Usually, common stock allows the shareholder to vote, but preferred stock often does not confer voting rights.
Dividends
Both common and preferred stockholders can receive dividends from a company. However, preferred stock dividends are specified in advance based on the share's par or face value and the dividend rate of the stock. Businesses can choose whether or not and how much to pay in dividends to common stockholders.
Should a company not have enough money to pay all stockholders dividends, preferred stockholders have priority over common stockholders and get paid first. For holders of cumulative preferred stock, any skipped dividend payments accumulate as “dividends in arrears” and must be paid before dividends are issued to common stockholders.
Trading and Price Changes
Common stock and preferred stock trade on the open market. Investors can choose to purchase or sell either type of share.
However, investors generally trade common stocks rather than preferred stocks. Due to their fixed dividends and lower risk profile, preferred stocks typically have less price volatility and greater growth potential than common stocks. Because of their stable dividends and lower volatility, preferred stocks are often favored by institutional investors pursuing a predictable income stream. These stocks are also normally less liquid than common stocks, meaning they are traded less frequently, making them less suitable for retail investors looking for short-term gains.
Corporate Bankruptcy
For common stock, when a company goes bankrupt, the common stockholders do not receive their share of the assets until after creditors, bondholders, and preferred shareholders. This makes common stock riskier than debt or preferred shares.
The upside to common shares is they usually outperform bonds and preferred shares in the long run. Most companies issue all three types of securities. For example, Wells Fargo & Company has several bonds available on the secondary market: preferred stock, such as its Series L (WFC-L), and common stock (WFC).
Initial Public Offerings
For a company to issue stock, it initiates an initial public offering (IPO). An IPO is a major way for a company seeking additional capital to expand the enterprise. To begin the IPO process, a company works with an underwriting investment bank to determine the type and price of the stock. Once the IPO is complete, the stock becomes available for purchase by the general public on the secondary market.
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Advantages and Disadvantages
Both common stock and preferred stock have pros and cons for investors to consider.
Pros and Cons of Common Stock
Pros
More frequently traded than preferred stock
Higher potential returns
Voting rights
Cons
May not receive dividends
Lower priority to receive dividends or in the event of bankruptcy
More price volatility
Pros and Cons of Preferred Stock
Pros
Higher priority to receive dividends
Less price volatility
Fixed dividends that won't decrease
Cons
May lack voting rights
Lower potential returns
Traded less frequently
How to Invest in Common Stock
Stocks should be considered an important part of any investor’s portfolio. They carry greater risk than assets like CDs, preferred stocks, and bonds. However, the greater risk comes with a higher potential for rewards. Over the long term, stocks tend to outperform other investments but in the short term have more volatility.
Investors can choose from different kinds of common stock. Growth stocks belong to companies expected to experience increasing earnings, which raises their share value. Meanwhile, value stocks are priced lower relative to their fundamentals and often pay dividends, unlike growth stocks.
Stocks are also classified by market capitalization into large-, mid-, and small-cap categories. Large-cap stocks are more frequently traded and usually represent well-established, stable companies. In contrast, small-cap stocks often belong to newer, growth-oriented firms and tend to be more volatile.
How to Invest in Preferred Stock
Investors can trade for preferred stock just like common stock. However, because of how they differ from common stock, investors need a different approach when investing in them.
Researching the issuing company is essential. Investing in preferred stock from a shaky company is as risky as buying its common stock. If the company fares poorly, both types of stock are likely to produce losses.
One key thing to consider when choosing preferred stock is the dividend. Compare the dividends you'll receive relative to the share price to determine if the yield offers an attractive return. A better yield can result in greater returns.
Moreover, take note of whether the stock is callable or convertible. Callable preferred stocks can be repurchased by the issuer at a preset date and price, causing you to miss out on future dividends. Convertible preferred stock, meanwhile, can be converted into common stock at the company's discretion, which can be an advantage if the price of the common stock rises significantly.
How Do I Use Common Stock to Vote at Company Meetings?
Most ordinary common shares come with one vote per share, granting shareholders the right to vote on corporate actions, often conducted at company shareholder meeting. If you cannot attend, you can cast your vote by proxy, where a third party will vote on your behalf. The most important votes are taken on issues like the company engaging in a merger or acquisition, whom to elect to the board of directors, or whether to approve stock splits or dividends.
Why Is Common Stock Called an Equity?
Common stock represents a residual ownership stake in a company, the right to claim any other corporate assets after all other financial obligations have been met. A company maintains a balance sheet composed of assets and liabilities. Assets include what the company owns or is owed, such as its property, equipment, cash reserves, and accounts receivable. On the other side of the ledger are liabilities, which are what the company owes. These include payables, debts, and other obligations. If a company is healthy, the total assets will be larger than the total liabilities. The residual amount left to the owners is known as shareholders' equity and is represented by a company's shares.
Why Do Companies Issue Preferred Stock?
Selling preferred stock, like any other shares, lets a company raise money by selling a stake in the business. A company may do this to raise capital for business expansion, debt repayment, or to invest in new projects. Preferred stocks are less dilutive of company ownership since they do not come with voting rights. They offer the issuing firm other benefits, not least because being less volatile makes them appeal to different investors. The fixed dividends also stabilize the company's balance sheet, making it more attractive to additional investors. Another reason is that, for some companies, the cost of issuing preferred stock is lower than issuing bonds. Unlike interest payments on bonds, dividends on preferred stock are not mandatory and generally are not tax-deductible for the corporation. However, they might still be less costly than the higher interest rates a company might have to pay to entice bond investors.
Is Preferred or Common Stock a Better Investment?
Each type has pros and cons. Common stock tends to offer higher potential returns, but more volatility. Preferred stock may be less volatile but have a lower potential for returns. This suggests that long-term investors who can handle greater volatility will prefer common stock, while those who want to avoid such fluctuations are more likely to choose preferred stock.
Are There Other Different Types of Stock?
Common and Preferred are the two major types. Some companies issue different classes of stock or even types of common stock. For example, Alphabet, the parent company of Google, has two classes of common stock: GOOG and GOOGL.
The Bottom Line
Common stock, as its name implies, is one of the most ordinary types of stock. It gives shareholders a stake in the underlying business, as well as voting rights to elect a board of directors and a claim to a portion of the company's assets and future revenues. However, common stockholders have a lower position than preferred stockholders, who get priority on dividend payments and in recovering their investment if the company is liquidated.
