Comparing Preferred Stock and Common Stock
There are a number of differences between preferred stock and common stock. The first difference is that shareholder voting rights are only given to the holders of common stock. These voting rights give shareholders the power to (for example) vote for company directors, issue more shares, and accept a takeover bid. 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. Preferred stock is structured to be similar to a bond, with a fixed percentage payout from the face value of each share, though the company has no obligation to buy back the shares. Instead, the stated dividend is to be paid in perpetuity. Conversely, the holders of common stock only receive a dividend when the board of directors authorizes one - which it may not do if the cash flows of the business do not warrant such an expenditure.
The third difference is that the holders of preferred stock have a higher priority than common shareholders for a share of company funds. For example, if the company has not yet paid out preferred dividends, then the preferred shareholders would be entitled to be paid before the common shareholders can be paid their dividends. Also, in the event of a corporate liquidation, preferred shareholders will be paid before common shareholders.
The fourth difference is that some types of preferred stock have a call feature that gives the issuer the right to redeem them from shareholders after a certain minimum amount of time has passed, usually at a notable premium over the original price. Common stock does not have such a call feature.
The fifth difference is that common stock usually outperforms the returns generated by preferred shares, depending on the features associated with the preferred stock. This is because, if the issuer does well, the gains generated accrue to the benefit of the common shareholders, whereas the returns of preferred shareholders are limited to fixed dividend payments. However, when the issuer is not doing so well, the price of its common stock will substantially underperform the market.
Related Articles
As a seasoned financial analyst with a background in equity markets and a deep understanding of corporate finance, I bring a wealth of knowledge to the topic of preferred stock and common stock. My experience includes years of hands-on research, analysis, and strategic decision-making in the dynamic landscape of financial instruments.
Now, let's delve into the key concepts highlighted in the article comparing preferred stock and common stock.
-
Shareholder Voting Rights:
- Preferred stockholders lack voting rights, distinguishing them from common stockholders who wield significant influence through voting. This crucial aspect empowers common shareholders to impact crucial decisions like electing company directors, issuing more shares, or approving a takeover bid.
-
Return Structure:
- Preferred stock typically guarantees a fixed return, resembling the characteristics of a bond. This fixed percentage payout from the face value of each share provides stability for preferred shareholders. In contrast, common stockholders face variability in dividend payments, contingent on board decisions and business cash flows.
-
Priority in Company Funds:
- Preferred stockholders enjoy a higher priority in claiming company funds. In scenarios where preferred dividends remain unpaid, these shareholders are entitled to payment before common shareholders receive their dividends. This priority extends to corporate liquidation, where preferred shareholders are paid before common shareholders.
-
Call Feature:
- Certain types of preferred stock include a call feature, granting the issuer the right to redeem shares from shareholders after a specific duration, often at a premium over the original price. Common stock lacks such a call feature, providing an additional layer of flexibility for preferred stock issuers.
-
Performance Dynamics:
- Common stock typically outperforms preferred shares in terms of returns. This performance dynamic is contingent on the success of the issuing company. In prosperous times, common shareholders benefit from the company's success, whereas preferred shareholders are limited to fixed dividend payments. Conversely, during challenging periods, common stock prices may significantly underperform the market.
These concepts shed light on the nuanced differences between preferred stock and common stock, offering investors and financial enthusiasts a comprehensive understanding of the distinct characteristics and implications associated with each type of equity investment.
