Common stock and preferred stock are two fundamental stock types. Both stock types represent ownership in the company and are traded. In addition to their similarities, there are also some main differences between them. In this article, we will summarize these differences between common stocks and preferred stocks.
Differences between common stocks and preferred stocks are mostly based on voting rights, dividends, risks, priority to claim on the company’s assets and liquidation.
Let’s firstly talk about the voting rights. While holders of common stocks have voting rights to select the company’s board of directors, preferred stockholders have no rights to vote for board of directors. Common stock investors have one vote per each stock that they hold. They can affect and control the corporate policy and management issues. If an investor holds 10% of common stocks of a company, this investor will entitle to one-tenth of the total votes.
Second main difference between common stock and preferred stock is related to the dividends. Dividends for preferred stocks are usually higher than dividends for common stocks. Also, preferred stockholders have priority and guarantee for dividends. A company firstly pays dividends to preferred stockholders, and then pays to common stockholders. In addition, common stockholders get dividends depending on how the company is profitable, but preferred stockholders get dividends at regular periods like bondholders. Thus preferred stocks may considered as a mix of common stock and bond. That is, it gives ownership right to the holders like common stock but gives no voting right like bonds. The investors choose preferred stocks over bonds since they get higher yields from preferred stocks than bonds, but they are riskier than bonds. Moreover, while common stockholders do not know how much they will receive dividends, preferred stockholders know the dividend amount that they will get. But note that it does not meant that preferred stockholders will certainly get higher dividends in a period.
When we look at third difference, we can say that preferred stocks are riskier than common stocks. Risk of preferred stocks is that they are interest rate sensitive. When interest rates are low, preferred stocks are invested because dividend rates of them higher than the yield of bonds. However, with the increases of interest rates, investors will invest to the bonds. Therefore, a smart investor should sell the preferred stocks depending on the increases in interest rates. On the other hand, common stocks potentially give higher value than others to the investors in the long run if the value of the company goes up. We know that markets fluctuate in time. When common stock’s value goes to zero, stockholders will get nothing. However, preferred stockholders get their initial investments by holding until the maturity.
Fourth difference is that preferred stockholders have claim on the company’s assets before common stockholders. Common stockholders are paid after creditors, bondholders, and preferred stockholders during a bankruptcy.
We hope that above summary of differences between common stocks and preferred stocks will help you during your investments in the stock markets.