What Is the Difference Between Common Stock and Preferred Stock?

Preferred and common stocks are great ways to invest in the U.S. stock market and grow your wealth. But what is the difference between common stock and the various preferred stock types? We’ll break down each type of investment and compare their strengths and weaknesses.

What Is Common Stock?

Common stock is a representation of ownership in a publicly-traded company. The more common stocks you have, the more ownership you have over the company. Common stocks are also tied to privileges, giving you the power to vote on certain decisions within the company, such as electing new members to the board of directors or deciding on new corporate objectives. Let us now take a look at some pros and cons of common stock. 

Pros of Common Stock

• Limitless returns: Other investment products, such as bonds or deposit certificates, have a minimum and maximum return on investment. Equity ownership does not have these limitations, which means that the growth potential of the investment is high if the company you invest in is successful.
• Simple buying and selling process:  The overall secondary market for equity shares is highly liquid and offers seamless transactions for investors. Common stocks can be bought and sold anytime the stock market is open. Shrinking and growing your investments is just a few clicks away.
• Two ways to benefit: Common stocks give you access to two different earnings: capital gains and dividends. If the value of your stock increases, you will earn capital gains. If the business’s profits reach a surplus, your stocks also give you the option to receive dividend payments.

Cons of Common Stock

• High risk: As we mentioned earlier, there is no maximum or minimum return on your investment. Since risk and returns are directly related, there are chances that you may lose all of your money with common stocks. While you can usually sell before making a total loss, your common stocks may not always be as lucrative as you’d hoped
• Volatile investment: A company’s stock volatility is dependent upon various factors like investor’s sentiment, earnings release, company or global news, etc.;  the value can tank in days. If you’re not keeping a watchful eye on your investments, they may bring your portfolio into the red.
• Low priority: Even though common stock signifies ownership in the company, common stockholders are the last to get paid for dividends and any proceeds in an event of company liquidation. Liquidation preference places employees, creditors, suppliers, and preferred stockholders ahead in the payout hierarchy, and whatever’s left is shared among common stockholders, which may not be very much.

What are the Different Types of Preferred Stocks?

Although not very common, various types of preferred stock exist that can make the investment offering even more lucrative. Some of these are as follows:

• Convertible Preferred Stocks: These types of preferred stocks help the investor enjoy the flexibility to convert their preferred stock into a common stock! The conversion ratio is pre-determined, and the investor holds the right to convert their holdings into common stock at their discretion.
• Participating Preferred Stock: These types of preferred stocks offer shareholders the right to participate in the company’s decision-making processes, such as voting on key matters. 
• Callable Preferred Stock: These types of preferred stock give the issuing company the right to repurchase the stock from shareholders at a predetermined price.
• Cumulative Preferred Stocks: These stocks offer an advantage to the stockholder by ensuring the right to receive any unpaid dividends from the company before the issuing company can issue any further dividends. With these stocks, the dividends accumulate and must be paid out to the preferred shareholders before they can be paid out to the common shareholders
• Non-Cumulative Preferred Stocks: As the name suggests, these preference shares do not offer a cumulative benefit to the preference shareholders. i.e., if the issuing company misses a dividend payment, then the shareholder forfeits the right to claim it in the future.

What Is Preferred Stock?

Preferred stocks are what many consider to be the cross-section between common stocks and bonds. Like common stocks, preferred stocks give you a share of the company. However, they also include further protections; preferred stockholders are prioritized more than common

stockholders for dividend payments. Let us now look at some pros and cons of preferred stock. 

Pros of Preferred Stock

• Regular dividend payments: Preferred stocks usually pay dividends on a regular schedule. These dividend payments are fixed, meaning they won’t grow and shrink with the company’s performance. These fixed dividends can significantly enhance the overall returns on the investment over a long-term horizon.
• Higher priority: As we’ve already mentioned, preferred stockholders have a higher priority for receiving dividends and payments from liquidation. 
• Par value: Preferred stocks have a minimum value for which they can be redeemed. Therefore, you’ll never lose all of your money if the company goes bankrupt.

Cons of Preferred Stock

• Fewer rights: While common stockholders have voting rights within the company, preferred stockholders do not. If they do have voting rights, they are usually limited in nature.
• Less opportunity for growth: Preferred stocks are much less volatile than common stocks, meaning you have less chance to see significant returns on your investment. Preferred stocks generally exhibit less price fluctuation compared to common stocks, which may result in more predictable dividend income but limited scope for significant investment gains.
• Interest rate influence: Preferred stock is interest-rate sensitive, meaning they are not great investments when interest rates increase. Since interest rates generally take a long time to change, this can seriously affect your investments.

What Is the Difference Between Preferred and Common Stock?

Now that we know more about common and preferred stocks, we will answer the question-  what is the difference between common stock and preferred stock? Here’s a simple breakdown:

Common stocks are high risk and have a higher reward potential but do not give you priority for dividend payments. They also offer you voting rights in the company.

Preferred stocks are at lower risk and have a lower reward potential but do give out consistent fixed dividend payments. They do not give you much voting rights in the company (if any).

Invest in Common Stock and with Vested Finance

Both types of stocks have their advantages and disadvantages. A balanced investment in both types can help capitalize on their distinct advantages. Leveraging these financial instruments efficiently can help boost one’s stock market investment substantially. Additionally, having a diverse portfolio can supplement your financial resources.

Use Vested Finance to learn more about investing—we’ll share the knowledge you need to be successful.