Common stock possesses voting rights and experiences price appreciation in line with market prices, while preferred stock lacks these privileges.
However, preferred stock enjoys higher priority dividend payments and liquidity rights in the event of insolvency. The disadvantage of preferred stock lies in its lack of voting rights and callable nature.
Introduction
In investing, stocks represent a key component of a well-diversified portfolio. When purchasing a company’s stock, you essentially buy a piece of that company, becoming a shareholder. Companies issue two main types of stock: common and preferred. Each type comes with its own set of features, benefits, and drawbacks.
Understanding Different Types of Stocks
Understanding the nuances between common and preferred stock can be pivotal to potential investors’ financial success. This knowledge empowers investors to align their investment strategies with their financial goals and risk tolerance.
For instance, common stocks generally appeal to those who are willing to absorb more risk for the potential of higher returns. In contrast, preferred stocks may be more suitable for conservative investors desiring steady income. By comprehending these differences, investors can make informed decisions, maximizing their potential returns while mitigating risks.
Key Takeaways
- Both common and preferred stocks represent ownership in a company but have distinct differences, such as dividend payments, voting rights, liquidation rights, and capital appreciation potential, that investors should consider based on their risk tolerance, income needs, and investment goals.
- Common stock investors, willing to take on higher risk for potential capital appreciation, often deploy strategies like long-term growth, dividend reinvestment, and value investing that involve thorough research and carefully considering a company’s financial health and future growth prospects.
- Preferred stock investors, likely seeking stable income and lower risk, may use income, defensive, and convertible preferred stock strategies. Preferred stocks offer fixed, often guaranteed dividends and a higher claim on assets in case of liquidation, and some are convertible into common stocks.
The Difference Between Common and Preferred Stock
Common stock has voting rights and price appreciation in line with market prices, whereas preferred stock does not. However, preferred stock has higher priority dividend payments and liquidity rights in case of insolvency. The downside of preferred stock is that it has no voting rights, and they are callable.
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What is a Stock?
A stock, otherwise called equity, is an ownership interest in a company. Buying a company’s stock means buying a portion of the business, giving you a stake in its operations and profits.
Common Stock and Preferred Stock
Common and preferred stock are the two primary types of stock that companies issue to investors.
Common stock is the most popular type of stock. It grants shareholders voting rights in addition to potential dividends and capital gains. Common shares are also considered riskier than preferred shares since their dividend payments can be canceled or reduced at any time.
Preferred stock provides investors a steady income stream through fixed dividends paid out before common stockholders. Preferred shareholders do not have voting rights but receive priority for any dividends the company pays. Additionally, preferred stocks usually have a higher claim on the company’s assets than common stock if it liquidates.
Example: Common vs. Preferred Stock Price Performance
This chart shows the difference between the stock price performance of Wells Fargo Company (Ticker: WFC) common and preferred stock. Over the last two years, the preferred stock has declined in value from $25 to $19 -24%, whereas the common stock has increased from $23 to + 44 +44%.
See this Chart & Find Preferred Stock on TradingView
The Wells Fargo depository share (above) is an example of a preferred stock that has non-voting rights but provides higher dividend payouts than common shares. This type of stock is not as liquid as common share prices and can be more expensive to purchase due to the higher dividends they offer.
Common Stock
Common stock gives investors the right to vote in shareholder meetings, though generally, one share equals just one vote. Common stocks also entitle owners to dividends, depending on how well the company performs. Common stocks have a greater potential for high returns due to their ability to appreciate in value and pay out dividends. However, they may also be subject to greater risks, such as the possibility of losses on the original investment.
Preferred Stock
In contrast, preferred stocks are less volatile and more stable than common stocks. They may provide a fixed dividend rate paid out regularly, regardless of how well the company does. Investors typically do not have voting rights with preferred stocks, so they cannot influence the company’s operations that way. However, if the company were to dissolve, preferred stockholders would be first in line for compensation after creditors and bondholders.
Takeaways
Each type of stock has benefits and risks. Investors need to understand these differences before making any purchase decisions. Common stocks have the potential for higher returns, while preferred stocks are more stable investments. By becoming familiar with each type of stock and its associated features, investors can make informed decisions that better align with their financial goals and risk tolerance.
Common vs. Preferred Stock Recap
Common stockholders have voting rights but are last in line to receive any remaining assets if the company goes bankrupt. Preferred stockholders, conversely, usually don’t have voting rights, but they have a higher claim on assets and earnings. This means they receive dividends before common stockholders and have a higher claim in case of liquidation.
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Common Stock: An Overview
As the name suggests, common stock is the most common type of stock that investors purchase. It represents a share in a company’s ownership and a claim on a proportion of the company’s profits or losses. Investors who hold common stock exercise ownership rights by voting in the company’s annual general meetings, influencing decisions about the company’s board of directors and future business directions.
The primary characteristic of common stock is its potential for high returns. If the company performs well financially, the price of its common stock typically increases, allowing shareholders to sell their stock for a profit. Additionally, common stockholders may receive dividends, a share of the company’s profits distributed periodically to its shareholders. However, such dividends are not guaranteed and depend on the company’s profitability and dividend policy.
One key risk associated with common stocks is their vulnerability to market fluctuations. While they can provide significant returns, they can also result in losses if the company underperforms or the broader market declines. In the event of a company’s liquidation, common stockholders are last in line to receive any remaining assets, after bondholders and preferred stockholders. Therefore, while common stocks offer high growth potential, they also have higher risk than other investment options.
Rights and Privileges of Common Stockholders
Thanks to their ownership stake in the company, common stockholders enjoy rights and privileges like voting, dividend, liquidation, preemptive, and information rights.
Voting Rights
One of the most significant rights of common stockholders is the ability to vote at the company’s annual general meetings (AGMs). Usually, each share of common stock equates to one vote. These votes influence vital decisions such as electing the board of directors, approving major corporate initiatives, and deciding on other key company policies.
Dividend Rights
Common stockholders may be eligible to receive dividends, a portion of the company’s profits distributed to shareholders. However, dividends are not guaranteed and depend on the company’s financial health and dividend distribution policy.
Right to Information
Common stockholders have the right to access certain essential information about the company. This includes financial statements, company operations information, and other disclosures.
Rights on Liquidation
In the event of the company’s liquidation, common stockholders have a claim on the company’s remaining assets after all debts and preferred stock dividends have been paid. However, they rank last, following creditors, bondholders, and preferred stockholders.
Preemptive Rights
Sometimes, common stockholders have preemptive rights, allowing them to maintain their proportional ownership in the company if more shares are issued. This means they have the first chance to purchase additional shares before the company offers them to new investors.
Capital Appreciation
If the company performs well, the value of common stocks may increase over time, providing the potential for capital appreciation. This means that stockholders could sell their shares at a higher price than the purchase price, realizing a profit.
It’s important to note that these rights can vary depending on the company’s policy and the jurisdiction in which the company operates.
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Preferred Stock: An Overview
Preferred stock, often referred to as preference shares, is another type of investment in a company that represents a higher claim on the company’s assets and earnings than common stocks. These shares are named “preferred” because the investors who hold them have a priority over common stockholders regarding dividend payments and the distribution of assets in case of corporate liquidation.
The primary characteristic of preferred stock is its fixed dividend, which is usually stated as a percentage of the stock’s par value. This dividend is paid out before dividends are given to common stockholders, offering more income stability. Unlike common stocks, these dividends are typically guaranteed, making preferred stocks a more predictable, income-generating investment.
Rights and Privileges of Preferred Stockholders
The rights and privileges of preferred stockholders differ from those of common stockholders.
Dividend Rights
Preferred stockholders have priority over common stockholders when it comes to receiving dividends. They receive a regular fixed dividend, typically stated as a percentage of the share’s par value. This is usually paid out before dividends are given to common stocks, meaning preferred stocks offer more income stability.
Liquidation Rights
In the event of liquidation, preferred stockholders rank higher than common stockholders, making them less risky investments overall. They have a higher claim on the company’s remaining assets after bondholders and creditors are paid out.
Callable
Preferred stocks can be callable, meaning the issuing company has the right to purchase the stock back from shareholders at a predetermined price after a specified date. This can limit the capital appreciation potential for preferred stockholders.
Voting Rights
Preferred stocks usually carry limited or no voting rights, meaning they have less influence over the company’s direction and policies than common stockholders.
Overall, preferred stocks are generally a more secure and steady investment than common stocks. They offer investors the potential to earn a steady income from dividends while still participating in the company’s performance.
Key Differences Between Common Stock and Preferred Stock
While both common and preferred stocks represent ownership in a company, they have distinct differences that investors should consider before deciding which to purchase.
Dividend Payments
Common stockholders are entitled to dividends, which are not guaranteed and depend on the company’s profitability. In contrast, preferred stockholders receive fixed dividends that are usually guaranteed, providing a more stable and predictable income stream.
Voting Rights
Common stockholders often have the privilege to vote on company matters, including board member elections, which allows them to influence the company’s direction. Preferred stockholders, on the other hand, typically have no or limited voting rights, making them less influential in the company’s decision-making process.
Liquidation Rights
In corporate liquidation, preferred stockholders have a higher claim on the company’s assets than common stockholders. This means that if a company goes bankrupt, preferred stockholders are more likely to receive some portion of their investment back.
Capital Appreciation Potential
Common stocks carry a higher risk but have a higher potential for capital appreciation. If the company performs well, the price of common stocks can significantly increase. Preferred stocks, however, usually have limited capital appreciation potential, particularly if they are callable.
Thus, investing in common or preferred stocks depends on individual investors’ risk tolerance, income needs, and investment goals. It is recommended to thoroughly understand the features of both types of stocks and analyze the company’s prospects before investing.
Investment Strategies for Common and Preferred Stocks
Due to their inherent characteristics, different strategies must be considered when investing in common and preferred stocks.
Common Stock Investment Strategies
Investing in common stocks requires a diligent approach involving careful research and consideration of a company’s financial health, industry position, and future growth prospects. Given the higher risk and the potential for capital appreciation, a common stock investment strategy often includes:
Long-term Growth Strategy
Here, investors seek companies with promising long-term growth prospects. They are willing to tolerate market volatility in the expectation of substantial future returns.
Dividend Reinvestment Strategy
Investors who opt for this strategy reinvest the dividends from common stocks into buying more company shares, compounding their investment over time.
Value Investing
This strategy involves identifying and investing in undervalued stocks – companies believed to trade for less than their intrinsic values.
Preferred Stock Investment Strategies
On the other hand, investing in preferred stocks is typically driven by the desire for stable income and lower risk. Thus, common strategies include:
Income Strategy
Given their fixed, often guaranteed dividends, preferred stocks are popular for income-focused investors. These stable payments can be particularly attractive to retirees or those seeking regular income.
Defensive Strategy
Preferred stocks may also be used as part of a defensive strategy due to their higher claim on assets in case of liquidation. During turbulent market periods, preferred stocks can provide a safety net.
Convertible Preferred Stock Strategy
Some preferred stocks are convertible into common stocks. Investors using this strategy can enjoy the fixed income from the preferred stock and potentially benefit from the capital appreciation if converted to common stock.
Each investor’s strategy will depend on financial goals, risk tolerance, and investment horizon. As always, it is recommended to conduct thorough research or consult with a financial advisor before making investment decisions.
Does Warren Buffett Invest in Preferred Stock?
Warren Buffett is known for his distinctive value investing style and long-term growth strategy. His company, Berkshire Hathaway, typically invests in undervalued companies with strong growth potential, a strategy more aligned with common stock investing.
However, that’s not to say Buffett completely avoids preferred stocks. In fact, during the 2008 financial crisis, he made a significant investment in preferred shares of Goldman Sachs and General Electric, attracted by their high dividend yields and stability amidst the market turmoil.
Still, these instances are more the exception than the rule in Buffett’s investment approach. His preference generally leans towards common stocks, particularly those of companies with sturdy economic moats and sustainable competitive advantages.
Conclusion
Common and preferred stocks represent ownership in a company but have distinct qualities that investors need to consider when investing. Common stocks have a higher potential for capital appreciation but involve greater risks. Preferred stocks offer more stability and often guarantee fixed dividend payments, making them attractive for income-focused investors and those seeking safety nets during market volatility.
Ultimately, the type of stock and the investment strategy chosen should be based on individual financial goals and risk tolerance. Thus, it is important to research and understand the features of each before making any decisions.
Buffett’s value investing style typically favors common stocks over preferred stocks, but Buffett made exceptions during market turmoil when attractive dividend yields were available.
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FAQ
What is the best platform for common and preferred stocks?
TradingView is an excellent tool for screening common and preferred stocks. It has powerful scanning capabilities and analytics tools to help you quickly uncover stocks with strong dividend yields and earnings growth.
How do dividends work for common vs. preferred stock?
Common stock dividends vary and are not guaranteed, while preferred stock dividends are usually fixed and paid before any dividends to common stockholders.
Do all companies offer common and preferred stock?
No, it depends on the company's corporate structure. Some companies only issue common stock, while others offer common and preferred stocks.
What charting software shows preferred stocks?
According to our testing, the best software for dividend yield investing is Stock Rover for U.S. investors and TradingView for international markets. Both tools have free and premium services worth using.
Which has more voting rights, common or preferred stock?
Common stock typically comes with voting rights, allowing shareholders to influence corporate policy. Preferred stock usually has limited or no voting rights.
Are preferred stocks riskier than common stocks?
Generally, preferred stocks are less risky than common stocks because they have a higher claim on dividends and assets. However, they also have less potential for capital appreciation.
Can preferred stock be converted into common stock?
Yes, some preferred stocks, known as convertible preferred stocks, can be converted into a predetermined number of common stock shares.
Which type of stock typically has higher dividends?
Preferred stocks usually have higher dividends than common stocks, which are typically paid out before any dividends to common stockholders.
What happens to common and preferred stock in bankruptcy?
In case of bankruptcy, preferred stockholders are paid off before common stockholders. However, both are last in line behind creditors and bondholders.
What's the price behavior for common vs. preferred stocks?
Common stocks tend to be more volatile, offering higher potential gains and losses. Preferred stocks are generally more stable but offer less growth potential.
How does the liquidation preference work for preferred stocks?
If a company is liquidated, preferred stockholders get paid before common stockholders up to the par value of their shares, plus any unpaid dividends.
Can a company force me to sell my preferred shares?
Yes, some preferred stocks are callable, meaning the company can buy back the shares at a predetermined price.
What is cumulative preferred stock?
A cumulative preferred stock accumulates unpaid dividends, which must be paid out before any dividends can be paid to common stockholders.
What is the participating preferred stock?
Participating preferred stock allows holders to receive additional dividends beyond the stated rate, typically when profits exceed a certain level.
What is non-cumulative preferred stock?
Non-cumulative preferred stock does not accumulate unpaid dividends. If the company skips a dividend payment, the investor loses it forever.
Should I invest in common or preferred stocks?
If you want stable dividend income, then preferred stocks; if you seek stock price appreciation, common stocks are a better choice.
Where can I buy common and preferred stocks?
Both types of stocks can be purchased through brokerage firms, online trading platforms, or directly from the company in some cases.
