Common vs. Preferred Stock: How They Differ

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The main differences between common vs. preferred stock lies in the investors intention, how they receive profit, and the various risks involved.

In our previous article, we discussed that among the different types of stocks issued by a company, the two outstanding ones are common stock and preferred stock. 

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However, any investor who understands this would also want to know the difference between these two.  

Although, in this article, we are more concerned about the dissimilarity we will also talk about the similarities.

The definitions of common vs. preferred stock

For more emphasis and the sake of this article let us explain more about these two main types of stocks.

In a simple language, common stocks are those regular types of securities that investors purchase because of their advantage to ownership and other rights as compared to other stocks.

When you purchase a common stock from a company, you become part owner, and shareholder. Now as a shareholder, you have rights to voting, decision making, profits from the company, and claim to its assets.

A preferred or preference stock on the other hand is also a regular type of stock having similarity in ownership with common stock.

But unlike its name “preference” meaning first choice, the owners are given favorable rights as compared with common stockholders.

When you purchase a preference stock you not only become a shareholder but also occupy a unique position. This distinctive position comes in the company’s capital structure. For instance in the company’s dividend,

The difference in common vs. preference stock

Sometimes, one may ask why is common stock and preferred stock regarded as the primary type of stock. Why are other types of stocks not regarded in the same way?

The answer is simple; these two types of stock appeal most to investors. They understand that these stocks give access to ownership, provide stable income, and at the same time serve different purposes. Therefore, let us look at the dissimilarity that each one has compared to the other

1.  Right to ownership

Investors in common stock are part owners of a company. They have rights and more control over matters regarding Ownership of a company.  Such as voting in the meeting of shareholders, decision-making, and electing of board of directors.

While in preference stock, investors have no right to vote, make decisions, or elect any member of the board of directors. Thus they have no control over the company’s matters or governance. 

Hence, common and preferred stock has the similarity of ownership in a company.  

2. Payment of company’s profit (Dividend)

Investors in common stock receive their dividends based on the decisions of the shareholders. This decision is made based on the outcome of the company’s financial performance.

This simply means that common stockholder’s dividend is not guaranteed. Thus if the company performs badly or records much losses they may not receive any dividends. Hence, common stock holder’s dividend varies with price fluctuation.

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In preference stock, the investors are given preferential treatment regarding dividend payment. The dividends are fixed annually with a specific rate and they are paid regularly before common stockholders. If the company fails to pay dividends for a certain period the unpaid dividend becomes cumulative and must be paid.

3. Right and claim to assets

In terms of company liquidation, investors in common stock can exercise a claim on the company’s assets. This claim can only be effective when creditors, debtors, and preference stockholders have received theirs.

While in preference stock, investors are also given preferences to claim assets in terms of the company’s liquidation.  They claim their share ahead of common stock investors.

The difference here is that common stockholders may claim more assets because they have no fixed rate compared to preferred stockholders that has fixed rates.

4. Common stock is more liquid: this means it can be easily converted to cash compared to preference stock. Consequent to its liquidity, investors can easily make purchases and sell in the stock market.

5. Investors with common stock have more control and rights in the company information such as their financial reports. This authority makes them different as compared to preference shareholders.

6. Risk and rewards

In terms of rewards or profits common stockholders usually benefit more if the company performs well. Hence, their dividends are not fixed or specified but according to the company’s performance. 

If after paying the preference stockholders their fixed amount and also the creditors they can claim the remains. This gives them access to potential growth.

In terms of risk, common stocks are riskier than preference stocks.  They bear more risk when the price fluctuates which usually results in the company’s poor performance.

While the preference shareholders only get their fixed amount even if the company performs better than is expected. Although this can give them access to security they may lack potential growth

7. Preference stockholders can often convert their stocks into common stock if they wish. But this depends if the company has a provision for such in their article of association.

That is if such class of preference stock has conversion right.  While common stock cannot be directly converted

8. Some preference stock is redeemable. This means investors who purchase preference stock can also choose to redeem their stock at a certain price and date.

This also will be stipulated in the company’s article of association. Common stockholders typically do not have the right to redeem their stocks as preference stockholders do.  

Conclusion

In summary, both common stock and preference stock represents ownership in a company but give different opportunities and rights. The differences involve capital appreciation and different dividend claims.  

These features attract investor’s intention to primarily invest in them compared to other stocks. This is also the reason why it is considered the two major stocks among other stocks available for investment.

Now placing these two stocks side-by-side, you could be able to ascertain what one does and does not. However, in all both of them share one main characteristic of ownership.

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