Generally, there are multiple types of stocks. While most investors purchase and sell common stock, the preferred stock also exists. And each of these categories can be subdivided further into classes. Thus, this article examines the distinctions between preferred stock and common stock. Each variety has advantages and disadvantages, and investors may prefer one over another.
List of Contents
Preferred Stock
Preferred stock is a type of stock that pays owners a defined dividend. It has priority over common stock when it comes to receiving dividends. In addition, it also has more voting rights than the common stock. Even though it is called “preferred stock,” most investors do not favor this type of stock.
Moreover, preferred stock is comparable to bonds in several aspects. For instance, the dividend paid on preferred shares is typically the primary source of return on investment. In addition, there is a greater possibility that they may pay out a bigger yield than common shares. As with bonds, the performance of preferred stock improves when interest rates fall. Also, preferred stock has a par value, which refers to the price at which it was initially issued.
In addition, preferred stock can be called on a particular date in the future. Consequently, there is a chance that the call price will be higher than the price the investor paid. It is not possible to convert preferred stock into common stock. However, certain varieties of preferred stock can be converted into a set number of common stocks. This additional feature sets preferred stock apart from common stock. “Convertible preferred stock” refers to this particular kind of stock.
Short-term investors who cannot hold the common stock long enough to overcome share price declines may benefit from investing in preferred stock. This is because it tends to vary less than common stock. However, it also has less potential for long-term gain.
Pros & Cons
Pros
- It prefers common stock for payout in a liquidation and dividend payment.
- It has less probability of losing value.
- Investors can receive a dividend that is often greater than dividends on common stock.
Cons
- It often does not provide voting rights.
- Normally, share price growth is controlled at the redemption value.
Common Stock
The term common stock refers to a certain kind of stock. It is the stock that is the most frequently purchased by investors. It allows shareholders to exercise their ownership rights. Moreover, the common stock allows them to vote on significant issues such as the election of the board of directors. They are also given a voice in determining some management and policy matters. In most cases, one vote is associated with each share.
Compared to preferred stock, the value of common stock typically derives more from the share price growth over time than from dividends paid out on the shares. Although it has a greater potential for long-term growth, common stock is ranked lower on the priority list for dividend payments and payouts in the case of liquidation. The company’s creditors, suppliers, and preferred shareholders will be paid back before the company’s common stocks. The value of a company’s common stock is likewise more likely to be reduced to zero than the value of its preferred shares. As a result, investors with a longer-term perspective should consider purchasing common shares.
Pros & Cons
Pros
- Capital gains taxes are avoided until the stock is sold.
- There is no limit to how high the share price can rise.
- Voting privileges are granted.
Cons
- Lower priority than preferred stocks in receiving a dividend in the event of a liquidation.
- Dividends are paid out first to preferred stocks, then to common stocks.
- Dividends may not be received.
- Price volatility has maximized.
The Work of Stock Classes
In most instances, when a company issues common stock, there is just one class of stock. In certain circumstances, companies may issue various share classes, such as Class A, Class B, and Class C shares.
Class A shares are traditionally traded openly and come with one vote, exactly like other types of common stock. Class B shares, in contrast, may be restricted to firm owners and executives. In addition, they may have more than one vote per share. Lastly, Class C shares are typically similar to Class A shares but have no voting rights.
On the other hand, preferred stock may also have distinct classifications. Varying kinds of preferred stock have different dividend and distribution priorities in the event of liquidation. However, these classes remain superior to common shares. Each series of preferred stocks has its own dividend, call date, and other features similar to bonds.
Are Preferred Stocks More Secure Than Common Stocks?
Preferred stock is less risky than common stock since its interest or dividends must be paid before regular shareholders receive their dividends or interest. Therefore, this indicates that preferred stock takes precedence over common stock. However, while the preferred stock has less risk than common stock, it carries more risk than a bond.
Conclusion
If you compare the benefits and drawbacks of each type of stock, preferred stock may be preferable. However, just because the preferred stock has a greater priority for dividends and payouts, does not mean it is better. In general, common stock has a greater potential for long-term growth. Therefore it may be more suitable for long-term investors. Consequently, the type that is optimal for you relies on the circumstances.
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Source: Bankrate