Common Stocks vs. Preferred Stocks

When investing in the stock market, you’ll encounter different types of stocks. Two primary types are common stocks and preferred stocks. Understanding their differences is key to making informed investment choices.

Common Stocks

Common stocks are the most common type of equity investment. When you buy common stock, you are buying a piece of ownership in a company. This ownership comes with certain rights and potential benefits.

• Ownership and Voting Rights: Common stockholders have voting rights. This means they can vote on important company decisions, such as who should be on the board of directors. Voting power allows investors to influence the company’s direction.
• Dividends: Common stockholders may receive dividends, which are payments made from the company’s profits. However, these dividends are not guaranteed. The company’s board of directors decides if and how much to pay, and dividends can vary based on the company’s performance.
• Capital Gains: Investors in common stocks hope to make money by buying shares at a lower price and selling them at a higher price. This price increase is known as capital appreciation. If the company performs well, the stock price may rise, leading to potential gains for the investor.
• Risk: Common stockholders are last in line to get their money back if the company goes bankrupt. This means they may receive nothing if the company’s assets are insufficient to pay off all its debts.

Preferred Stocks

Preferred stocks are a type of equity security that has characteristics of both stocks and bonds. They are less common but offer unique benefits.

• Dividends: Preferred stockholders receive dividends at a fixed rate. Unlike common stock dividends, preferred dividends are usually more predictable and are paid before common stock dividends. This makes preferred stocks more stable for income-seeking investors.
• Priority in Liquidation: In case the company goes bankrupt, preferred stockholders have a higher claim on the company’s assets than common stockholders. This means they are more likely to get some return on their investment, but they still come after debt holders.
• No Voting Rights: Unlike common stockholders, preferred stockholders typically do not have voting rights. They don’t get to vote on company matters or elections to the board of directors.
• Fixed Income: Preferred stocks often provide a more consistent income stream because of their fixed dividends. However, they usually do not offer the same potential for price appreciation as common stocks.

Summary: Common stocks offer ownership, voting rights, and the potential for capital gains, but come with higher risk. Preferred stocks provide stable dividends and a higher claim in bankruptcy but typically lack voting rights and have less potential for significant price appreciation. Understanding these differences helps investors choose the type of stock that best fits their investment goals and risk tolerance.

References:

Graham, B. (2003). The intelligent investor: The definitive book on value investing. HarperCollins. ISBN 978-0062312683Siegel, J. J. (2014). 

Stocks for the long run: The definitive guide to financial market returns & long-term investment strategies (5th ed.). McGraw-Hill. ISBN 978-0071805861