Common Stock vs Preferred Stock - What is the Difference?
You’ve probably heard the term stock trading a thousand times before, but did you know that there are actually two different kinds of stock you can trade? The common stock vs preferred stock debate will be one you have to settle for yourself eventually as an investor, and in this quick guide we will cover the basics.
Preferred stock and common stock can both be purchased by any investor who wants to own a piece of a company, but what is the difference between the two and what should you consider before buying either?
Now we will cover the differences, and outline some of the pros and cons of owning both types.
The Difference Between the Two Types of Stock
Common stock is the everyday shares of a company which can be bought and sold freely at any brokerage either online or in the real world.
It’s the buying and selling of common stock that moves markets and most of what you see on CNBC and the financial channels monitors the activity of shareholders across the world.
Preferred stock is exactly the same in theory, meaning it is a small part of a company which you can own, but it has several characteristics which differentiate it from common stock.
First, preferred stock is considered more valuable than common stock. This means that preferred stockholders will typically get a bigger piece of the profits, and on the flipside, should a company go bankrupt, preferred stockholders will have a claim to any remaining assets before common stockholders.
Second, there are typically fixed dividends with preferred stock. In this sense, a preferred stockholder is more like a bondholder, and the company must pay a dividend on preferred stock, whereas it is usually up to the board of directors to determine whether a dividend is paid on common stock.
In essence, then, preferred stockholders are in an elite club within the company, and can both make more money and feel more secure.
Which brings us nicely to the pros of owning preferred stock.
The Advantages of Preferred Stock over Common Stock
Preferred stock has several advantages over common stock. They include:
- Greater Profit Potential - As mentioned above, preferred stockholders will enjoy a greater share of the profits when the money is rolling in and the company is doing well.
- Partial Control - Preferred stockholders can exercise greater influence over what happens within a company, including on important matters like voting for the board of directors and on corporate policy matters. That said, they do not get to vote on as wide a range of issues as common stockholders.
- Guaranteed Dividends - Preferred stock could almost be classed as a fixed income asset since dividends are basically guaranteed. They can be deferred for a period of time, but must be paid eventually.
- Less Volatility - Generally speaking, preferred stock is not as volatile as common stock. That’s mostly due to the fact that preferred shareholders know they have the first claim on any assets if things go south, and so don’t panic as quickly.
Even if the board decides the company hasn’t made enough to pay a dividend to common stockholders, those who own preferred stocks will still receive one.
If for any reason the company fails to pay them, they accumulate, meaning they must be paid out before any other payments when the company starts making money again.
Now, at this point you might be wondering why anyone would choose anything other than preferred stock. Let’s now look at advantages of owning common stock.
The Advantages of Common Stock over Preferred Stock
The advantages of owning common stock over preferred stock include:
- Greater Growth Potential - While preferred stock is usually more stable and less volatile, it likewise doesn’t grow as much and being less affected by market conditions necessarily means it won’t swing up as much when good things happen, either.
- Greater Wealth of Information - Unless you’re a sophisticated investor, it can be harder to find data on preferred stock, whereas there is a wealth of information available from endless sources on most common stock. This makes it easier to make sound decisions, as any experienced investor will tell you.
- Simpler & Easier - Without getting into too many confusing details, there are actually multiple types of preferred stock, ranging from ‘trust’ preferreds to ‘convertible’ preferreds. Common stock is much more straightforward and less daunting.
- Not Callable - This may seem counterintuitive, but preferred stock can be recalled by the board in certain circumstances, which means the holders of preferred stock might have to give up their positions, missing out on some of the income they hoped for. Common stock is not callable, and so common stockholders don’t have to worry about this.
How to Buy Common Stock or Preferred Stock
Buying common stock is a relatively straightforward and easy process, and can be done by holding an account with a broker. This might be an online account, in which case you will execute the trade yourself, or it might be with a real-world broker, in which case the broker will make the trades for you.
Buying preferred stock can be done at some online brokers, but the symbols are different and it is much better to buy with a real-world broker if it’s your first foray into preferred stock trading.
Don’t be surprised if even (s)he is a little confused by preferred stock. It’s not uncommon for even brokers to scratch their heads over the ins and outs of it.
Why Do Companies Offer Preferred Stock in the First Place?
Preferred stock is issued because it offers a fantastic means for a company to raise capital.
Due to the fact that it is basically a fixed income asset and is less volatile than common stock, many large institutions buy preferred stock.
Obviously, a pension fund has more cash at its disposal than your average investor, and so company’s issued preferred stock to attract these big, institutional investors.
Preferred stock also allows a company to obtain capital without increasing its overall debt, as issuing a bond would.
Which is better in the discussion of common stock vs Preferred stock depends on your goals as an investor.
For a greater yield and relative safety and security, it may be worth looking into preferred stock, whereas if you’re looking for hassle-free, simple access to the markets and/or are a growth investor, common stock probably represents a better choice for you.
Either way, you will need to do your research to make sound decisions. All the best with whatever you decide!