What Is the Difference Between Common and Preferred Stocks?

 

What Is Common Stock?

Common stock is the most widely held type of stock. When people say they own shares of a company, they usually mean common shares.

Key Features of Common Stock

• Ownership and Voting Rights: Common shareholders have ownership in the company and typically have voting rights. This means they can vote on corporate matters such as electing the board of directors and approving major company decisions. Each share usually equals one vote.

• Dividends: Common stockholders may receive dividends, but these are not guaranteed. Dividends on common stock depend on the company’s profitability and board decisions.

• Capital Appreciation: Common stockholders benefit from increases in stock price, which can lead to capital gains if the shares are sold at a higher price.

• Residual Claim on Assets: In the event of company liquidation, common shareholders have a claim on the company’s assets only after creditors and preferred shareholders have been paid. This makes common stock riskier in bankruptcy scenarios.

Why Companies Issue Common Stock

Companies issue common stock to raise capital for growth, expansion, and operations. By selling common shares, companies get cash without incurring debt but dilute existing ownership.

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What Is Preferred Stock?

Preferred stock is a class of ownership with characteristics of both equity and debt. It is called “preferred” because preferred shareholders receive priority over common shareholders in dividend payments and during liquidation.

Key Features of Preferred Stock

• Priority Dividends: Preferred shareholders receive dividends before common shareholders. These dividends are often fixed, meaning preferred stock pays a regular, predetermined dividend.

• No or Limited Voting Rights: Preferred stockholders usually do not have voting rights or have very limited voting power, meaning they don’t have much say in company decisions.

• Dividend Preference: If a company misses dividend payments, preferred dividends often accumulate (called cumulative preferred stock), and must be paid before any dividends to common shareholders.

• Priority in Liquidation: In the event of liquidation, preferred shareholders have a higher claim on assets than common shareholders but are behind debt holders.

• Hybrid Nature: Preferred stock has features of both stocks and bonds—providing income like bonds (fixed dividends) and potential for appreciation like stocks.

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Key Differences Between Common and Preferred Stocks

Feature	Common Stock	Preferred Stock
Ownership Rights	Yes, including voting rights	Limited or no voting rights
Dividends	Variable and not guaranteed	Fixed dividends, paid first
Dividend Priority	Last after preferred dividends	Paid before common dividends
Claim on Assets	Lowest priority in liquidation	Higher priority than common shares
Risk Level	Higher risk, higher reward potential	Lower risk, more stable income
Price Volatility	Generally more volatile	Less volatile, more stable price
Convertibility	Generally no convertibility	Some preferred stocks can convert into common shares
Voting Rights	Typically one vote per share	Usually no voting rights

Advantages and Disadvantages of Common Stock

Advantages

• Voting Rights: Ability to influence company decisions through voting.

• Capital Gains Potential: Possibility of large price appreciation over time.

• Liquidity: Common stocks are generally more actively traded and easier to buy/sell.

• Ownership: Represents true equity ownership in the company.

Disadvantages

• Dividend Uncertainty: Dividends are not guaranteed and can be cut.

• Higher Risk: In liquidation, common shareholders are last in line, increasing risk of losing investment.

• Price Volatility: Prices can fluctuate widely based on market conditions and company performance.

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Advantages and Disadvantages of Preferred Stock

Advantages

• Stable Income: Fixed dividends provide predictable income, appealing to income-focused investors.

• Dividend Priority: Receive dividends before common shareholders.

• Lower Risk: Higher claim on assets during liquidation reduces risk.

• Less Volatility: Preferred shares tend to have steadier prices.

Disadvantages

• Limited Voting Rights: Little or no influence over company management.

• Limited Capital Gains: Less potential for price appreciation compared to common stock.

• Interest Rate Sensitivity: Prices can be affected by changes in interest rates, similar to bonds.

• Callable Feature: Some preferred stocks can be called (redeemed) by the company at a set price, limiting upside.

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When Do Investors Choose Common vs. Preferred Stocks?

Why Choose Common Stock?

• If you want to participate in company growth and have a say in corporate governance, common stock is the right choice.

• Suitable for investors seeking capital appreciation and are comfortable with higher volatility.

• Ideal for long-term growth investors and those who want to benefit from potential stock price increases.

Why Choose Preferred Stock?

• Investors seeking steady, predictable income with less price volatility often prefer preferred stocks.

• Preferred stock suits conservative investors or retirees who want reliable dividend payments.

• Some investors use preferred stock to diversify fixed-income investments because of its bond-like characteristics.

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Examples to Illustrate the Difference

Common Stock Example:

Apple Inc. (AAPL) common stockholders have voting rights and can benefit from price appreciation. Dividends are paid but are not guaranteed to grow every year.

Preferred Stock Example:

A utility company like Duke Energy issues preferred stock that pays a fixed dividend of $3 per share annually. Preferred shareholders receive dividends before common shareholders but generally cannot vote.

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Conclusion

Common and preferred stocks represent two different ways to own a piece of a company. Each comes with unique features, risks, and rewards:

• Common stock offers voting rights and higher potential returns but carries more risk and uncertain dividends.

• Preferred stock offers dividend priority, stable income, and lower risk, but limited voting power and lower price appreciation potential.

For most retail investors, owning common stock is the primary way to participate in stock market growth. However, preferred stocks serve a valuable role for income-focused investors seeking stability.

Understanding these differences allows investors to tailor their portfolios to meet their financial goals, risk tolerance, and income needs.