May 1, 2023
Individual investors that are new to the stock market might wonder what the difference is between preferred stock and common stock. There are distinct differences between the two, but one isn’t necessarily better than the other.
Both stock types represent a piece of ownership in a company and both are used by retail shareholders to try to profit from the future successes of the business that issues the assets. Yet there are key features to both that make each class unique.
Let’s look at common stock first. Not surprisingly, common stock is the most common — the stock type most retail investors pick and by far the most typical type of stock issued by companies. When most individual shareholders talk about buying and selling stock, they are talking about common stock shares.
Common stock shareholders can claim profits (dividends) and confer voting rights. Usually common stock shareholders get one vote per share owned to vote on things like board members — a key feature that allows some control over corporate policy and shareholder issues.
Typically, common stock outperforms bonds and preferred shares. It’s also the type of stock that provides the biggest potential for gains since if the company does well, the value of the stock goes up. The inverse is true as well: If the company does poorly, the common stock value generally goes down.
Preferred stock gives retail shareholders a different set of rights than common stockholders.
Preferred shareholders receive dividends before common stockholders, but they generally don’t get corporate voting rights. So when it comes time for a company to elect a board of directors or vote on corporate policy, preferred shareholders have no voice in how the company is operated. Preferred stocks function similarly to bonds since owners of preferred shares are usually guaranteed a fixed dividend in perpetuity.
According to Investopedia, the dividend yield of a preferred stock is calculated as the dollar amount of a dividend divided by the price of the stock. This is often based on the par value before a preferred stock is offered. It's commonly calculated as a percentage of the current market price after it begins trading. This is different from common stock, which has variable dividends that are declared by the board of directors and never guaranteed. In fact, many companies do not pay out dividends to common stock at all.
Like bonds, preferred shares also have a par value which is affected by interest rates. When interest rates rise, the value of the preferred stock declines, and vice versa. With common stocks, however, the value of shares is regulated by demand and supply of the market participants.
Preferred shareholders also have a greater claim to a company's assets and earnings. Dividends tend to be higher for preferred stock and retail shareholders with preferred stock also receive priority over common stock shareholders when it comes to dividend payments. Preferred stock also have a callability trigger that gives the issuer the right to redeem the shares from the market after a predetermined time. According to Investopedia, investors who buy preferred shares have a real opportunity for these shares to be called back at a redemption rate representing a significant premium over their purchase price. The market for preferred shares often anticipates callbacks and prices may be bid up accordingly.
So which is the right stock type for you? That’s a decision that each individual investor must determine for themselves depending on if they want more stability and reliable income from the preferred shares or voting rights and the potential for more profits from the common shares. The decision is up to you.
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