Those looking to invest in publicly traded companies can easily do so by purchasing shares of stock on the open market. Broadly speaking, stock grants the investor a fractional ownership stake in the company.
For many years, this model has been a source of funding that has helped companies grow. They use the money received from stock sales to invest in growth, pay off debt, or ramp up their research and development. While there are other sources of funding such as issuing bonds, stocks allow anyone who wants to invest an opportunity to earn a return.
However, there’s more than just one type of stock. While most investors buy and sell what is known as common stock, there’s also something called preferred stock. And each of these types can be further divided into classes.
This article will look at the differences between common and preferred stock. Each type has its own set of pros and cons and may be better for some investors, but not for others.
Common stock vs. preferred stock: How they compare
Not all stock is created equal. Common stock and preferred stock are the two types of stock that are most often issued by publicly traded companies and they each come with their own set of pros and cons. Here, we’ll look at each type and examine their strengths and weaknesses.
Common stock
Common stock isn’t just common in name only; this type of stock is the one investors buy most often. It grants shareholders ownership rights and allows them to vote on important decisions such as electing the board of directors. They also get a say in certain policy decisions and management issues. Each share usually has one vote. Compared to preferred stock, common stock’s value tends to come more from its growth in share price over time rather than dividends.
Common stock has higher long-term growth potential but also has lower priority for dividends and a payout in the event of a liquidation. Lenders, suppliers and preferred shareholders are all in line for a payout ahead of common stockholders. Common stock also has a greater chance of dropping to zero than preferred stock.
Common stock tends to be better suited to long-term investors.
Pros
- Grants voting rights
- No limit on how much the share price can grow
- Taxes on capital gains are deferred until stock is sold
Cons
- Greater price volatility
- May receive no dividends
- Dividends are paid out to preferred shares first, then common shares
- Lower priority than preferred shares to receive a payout in a liquidation
Preferred stock
Preferred stock is a type of stock that pays shareholders a specified dividend and has priority over common stock for receiving dividends. Despite its name, preferred stock isn’t necessarily preferred by most investors (though it does have its benefits).
In many ways, preferred stock is like a bond. For example, the major source of return on a preferred stock is usually its dividend. They are also more likely to pay out a higher yield than common shares. Like bonds, preferred stock performs better when interest rates decline. And preferred stock has a par value, that is, a value it’s issued at and can typically be redeemed at, when the preferred shares mature.
Preferred stock also can be “called” (i.e., redeemed by the company) on a prespecified date. Thus, there is a possibility the call price could be higher than the price the investor paid. Another unique feature of some types of preferred stock is they can be converted into a fixed number of common shares; the reverse is not an option. This type of stock is called convertible preferred stock.
Preferred stock may be a better investment for short-term investors who can’t hold common stock long enough to overcome dips in the share price. This is because preferred stock tends to fluctuate a lot less, though it also has less potential for long-term growth than common stock.
Pros
- Receives a specified dividend that is often higher than common stock dividends
- Less chance of losing value
- Has priority over common stock for payout in a liquidation, as well as for receiving dividends
Cons
- Growth in share price is generally limited, up to the redemption value
- Often does not grant voting rights
How stock classes work
In most cases, there is only one class of stock when a company issues common stock. However, in some cases, companies may issue multiple share classes, often called Class A, Class B, and Class C shares, for example
Traditionally, Class A shares are publicly traded and come with one vote, just like any other type of common stock. Class B shares, on the other hand, may only be available to company owners and executives. In addition, they may have greater voting power than a single vote per share. Lastly, Class C shares tend to be much like Class A shares, but traditionally they have no voting rights.
Preferred stock can have different classes, too. In the case of preferred stock, different classes have different priorities in terms of dividends and a payout in a liquidation. But these classes still have priority over common shares. Like bonds, each series of preferred stock has its own dividend, call date and other terms.
How do you buy and sell preferred or common stocks?
Investors looking to purchase preferred or common stock will likely do so through a broker. Most online brokers have cut trading commissions to zero, so you won’t have to worry about high costs to place an order. If you go through a traditional broker, trading fees will likely be higher.
Once you’ve identified the security you’re interested in buying, you can place a trade order for the number of shares you’d like to purchase. Not all companies offer preferred stock, so be sure to check what’s available through your broker.
Here are some of the best online stock brokers to buy and sell stock.
Is preferred stock safer than common stock?
Yes, preferred stock is less risky than common stock because payments of interest or dividends on preferred stock are required to be paid before any payments to common shareholders. This means that preferred stock is senior to common stock. But a company’s bonds are senior to preferred stock, so while preferred stock comes with less risk than common, it does carry more risk than a bond.
Bottom line
If you look at a list of pros and cons for each type of stock, it might seem like preferred stock is better. However, while preferred stock has a higher priority for dividends and to receive a payout, that doesn’t necessarily mean preferred stock is better.
In general, common stock has greater long-term growth potential, meaning common stocks may be better suited for long-term investors. Thus, which type is better for you depends on your situation.
FAQs
Is preferred stock safer than common stock? Yes, preferred stock is less risky than common stock because payments of interest or dividends on preferred stock are required to be paid before any payments to common shareholders. This means that preferred stock is senior to common stock.
Why is preferred stock better than common stock? ›
As the name implies, preferred stock is a form of equity, but it gives investors a higher claim on a company's assets and earnings compared with common stock. That means in case of bankruptcy or liquidation, preferred shareholders are behind bondholders in terms of who gets paid first.
What are the 2 major differences between preferred stock and common stock? ›
In short, preferred shareholders have no control over the future of the company, while common shareholders can exercise some control over it. The second difference is that preferred stock generally offers shareholders a fixed return, whereas the holders of common stock may or may not receive a dividend.
What are the 3 characteristics typical for preferred stock compared to common stock? ›
Comparison
| Common Shares | Preferred Shares |
|---|
| Company Ownership | Yes | Yes |
| Voting Rights | Yes | No |
| Dividend | Variable | Fixed |
| Order of Claim to Earnings | Second | First |
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Preferred stocks do provide more stability and less risk than common stocks, though. While not guaranteed, their dividend payments are prioritized over common stock dividends and may even be back paid if a company can't afford them at any point in time.
Why would a company want to issue preferred stock? ›
Issuing preferred stock provides a company with a means of obtaining capital without increasing the company's overall level of outstanding debt. This helps keep the company's debt to equity (D/E) ratio, an important leverage measure for investors and analysts, at a lower, more attractive level.
What are the advantages and disadvantages of preferred stock? ›
Pros and Cons of Preferred Stock
| Pros | Cons |
|---|
| Regular dividends | Few or no voting rights |
| Low capital loss risk | Low capital gain potential |
| Right to dividends before common stockholders | Right to dividends only if funds remain after interest paid to bondholders |
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Disadvantages of Preference Shares
The main disadvantage of owning preference shares is that the investors in these vehicles don't enjoy the same voting rights as common shareholders. 1 This means that the company is not beholden to preferred shareholders the way it is to traditional equity shareholders.
Why is preferred stock riskier? ›
A big risk of owning preferred stocks is that shares are often sensitive to changes in interest rates. Because preferred stocks often pay dividends at average fixed rates in the 5% to 6% range, share prices typically fall as prevailing interest rates increase.
Who buys preferred stock? ›
As with all investments, the answer depends on your risk tolerance and investment goals. Preferred stock works well for those who want higher yields than bonds and the potential for more dividends compared to common shares. In short, preferred stock is riskier than bonds, but safer than common stock.
An investor who wants to diversify their portfolio and is looking for fixed income investments might want to consider buying preferred stocks. Because they act closer to how bonds work, some experts consider preferred stock a lesser risk investment than common stock.
Can you have both common and preferred stock? ›
Some corporations issue both common stock and preferred stock. However, most corporations issue only common stock. In other words, it is necessary that a business corporation issue common stock, but it is optional whether the corporation will decide to also issue preferred stock.
Why do investors purchase preferred stock? ›
Preferred stock is attractive as it usually offers higher fixed-income payments than bonds with a lower investment per share. Preferred stockholders also have a priority claim over common stocks for dividend payments and liquidation proceeds. Its price is usually more stable than common stock.
What are the two most important characteristics of common stocks? ›
Dividend Right – Entitled to earn dividends. Asset Rights – Entitled to receive remaining assets in the event of a liquidation.
What are the key characteristics of preferred stock? ›
Preferred stocks have dividend priority over common stock. The holders of preferred shares receive dividends before the holders of common shares. Preferred stockholders generally do not have voting rights in the company. Dividends payable on preference shares can be cumulative or noncumulative.
What are two disadvantages of owning a preferred stock? ›
Among the downsides of preferred shares, unlike common stockholders, preferred stockholders typically have no voting rights. And although preferred stocks offer greater price stability – a bond-like feature – they don't have a claim on residual profits.
Why is preferred stock cheaper than common? ›
Because preferred shares pay steady dividends, but lack voting rights, they will typically trade in the market for a value different from the same firm's common shares. Some preferred shares are callable, which means the issuer can recall them from investors, so these will sell at a discount.
Is Apple a common or preferred stock? ›
(AAPL), Exxon Mobil Corp. (XOM), Microsoft Corp. (MSFT), etc., offer preferred stock.
What are the major risks of preferred stock? ›
Investing in preferred securities is subject to greater credit risk, limited voting rights, interest rate and liquidity risks. Investing in the. Concentration of assets in one or a few sectors such as financial services may entail greater economic risk than a fully diversified portfolio.
Why don t companies issue preferred stock? ›
Most companies with solid credit ratings don't issue preferred stocks (except for regulatory reasons), since the dividend payments are not tax-deductible. Thus, preferred stocks are generally too expensive a form of capital for strong credits.
The share value of a preferred share will rise and fall with changes in interest rates, similar to a bond. Share value goes down when interest rates go up, and share value goes up when interest rates go down.
Can regular people buy preferred stock? ›
Though you can purchase preferred stock similar to how you'd purchase common stock, owners of preferred stock should have a better understanding of investment risk and pay closer attention to stock performance.
Do preferred stocks do well in a recession? ›
It's an equity return but without anywhere near the equity risk." Preferred stock and corporate bonds aren't without risk, of course. But they offer more safety than common shares—which are the first to lose out in a bankruptcy—and much higher returns.
Can you sell a preferred stock? ›
Preferred stocks can be bought and sold on exchanges (like their close cousin the common stock) at their par value, which is basically how much money companies are selling their preferred stock for.
Do employees get common or preferred stock? ›
There are several different types of stock, but the two most important are preferred stock and common stock. Founders and employees typically receive common stock. Investors usually receive preferred stock.
What does 6% preferred stock mean? ›
For example, 6% preferred stock means that the dividend equals 6% of the total par value of the outstanding shares. Except in unusual instances, no voting rights exist. Types include cumulative preferred stockand participating preferred stock.
What do owners of preferred stock not have the right to do? ›
Unlike common stock, preferred shareholders do not receive voting rights. Preferred stock is considered to be a hybrid between corporate bonds and common stock; this is because the dividend payment is paid out at a fixed rate.
What are two 2 advantages of investing in common stock? ›
Three characteristic benefits are typically granted to owners of ordinary shares: voting rights, gains, and limited liability. Common stock, through capital gains and ordinary dividends, has proven to be a great source of returns for investors, on average and over time.
What are the four 4 basic criteria of common stocks? ›
Investing has a set of four basic elements that investors use to break down a stock's value. In this article, we will look at four commonly used financial ratios—price-to-book (P/B) ratio, price-to-earnings (P/E) ratio, price-to-earnings growth (PEG) ratio, and dividend yield—and what they can tell you about a stock.
What are the two preferences of preferred stock? ›
In the United States there are two types of preferred stocks: straight preferreds and convertible preferreds. Straight preferreds are issued in perpetuity (although some are subject to call by the issuer, under certain conditions) and pay a stipulated dividend rate to the holder.
If preferred stocks have a fixed dividend, then we can calculate the value by discounting each of these payments to the present day. This fixed dividend is not guaranteed in common shares. If you take these payments and calculate the sum of the present values into perpetuity, you will find the value of the stock.
What is the conclusion of preferred stock? ›
Preferred Stock Valuation Conclusion
If the required rate of return is lower than the preferred dividend rate then the preferred stock will have a value above its par and vice versa. When the required rate of return is equal to the preferred dividend rate, then the value of the preferred stock will match its par value.
What are two 2 differences between common stock and bonds? ›
What's the difference between stocks and bonds? The main difference between stocks and bonds is that stocks give you partial ownership in a corporation, while bonds are a loan from you to a company or government.
What are the major differences between preferred stock and common stock quizlet? ›
Common stock is an ownership share in a publicly held corporation. Common shareholders have voting rights and may receive dividends. Preferred stock represents nonvoting shares in a corporation, usually paying a fixed stream of dividends.
How is the preferred stock different than the common stocks quizlet? ›
What is the difference between preferred and common stock? Preferred stock has no voting privileges but common stock does. Preferred stock has their stock holders get paid first. Common stock pays their dividend after preferred stock holders.
What are the two types of stocks What are the differences between the two? ›
Two major types of stocks are common stock and preferred stock. Common stock usually has voting rights. Preferred stock is usually non-voting, but often pays higher dividends.
Which of the following is true about preferred stock? ›
The preferred stockholder's dividend is generally fixed, but preferred stockholders can also get extra dividends if the company earns an extra profit.
What are the major advantages of bonds over common stock? ›
Bonds tend to be less volatile and less risky than stocks, and when held to maturity can offer more stable and consistent returns. Interest rates on bonds often tend to be higher than savings rates at banks, on CDs, or in money market accounts.
What are the major differences between preferred stock and bonds? ›
Bonds offer investors regular interest payments, while preferred stocks pay set dividends. Both bonds and preferred stocks are sensitive to interest rates, rising when they fall and vice versa. If a company declares bankruptcy and must shut down, bondholders are paid back first, ahead of preferred shareholders.
What are the 3 characteristics typical for preferred stock compared to common stock quizlet? ›
Characteristics of preferred stock:
- fixed div. payment.
- no maturity.
- cash dividends that are paid prior to distributions to common stockholders.
- no voting rights.
Both common stocks and preferred stocks represent an ownership stake in a company, have the ability to pay dividends and trade on an exchange.
What are the characteristics of preferred stock? ›
Preferred stocks have dividend priority over common stock. The holders of preferred shares receive dividends before the holders of common shares. Preferred stockholders generally do not have voting rights in the company. Dividends payable on preference shares can be cumulative or noncumulative.
Does preferred stock appreciate in value? ›
The market value of a preferred stock is not used to calculate dividend payments, but rather represents the value of the stock in the marketplace. It's possible for preferred stocks to appreciate in market value based on positive company valuation, although this is a less common result than with common stocks.
What does common stock give you the right to do? ›
Common shareholders are granted six rights: voting power, ownership, the right to transfer ownership, a claim to dividends, the right to inspect corporate documents, and the right to sue for wrongful acts.
