When it comes to investing, understanding the differences between common stock and preferred stock is crucial. While both types of stock represent ownership in a company, they have distinct characteristics and purposes. Let’s dive into the details and explore the key differences between common stock and preferred stock.
Common Stock vs. Preferred Stock: Key Differences
Here’s a summary of the major differences between common and preferred stock:
- Potential for Growth: Common stock offers more potential for growth, but also comes with greater fluctuations in share price.
- Dividends: Common stock dividends are paid out when declared by the corporation’s board of directors, whereas preferred stock dividends are more reliable and often higher than those of Treasuries or bonds.
- Conversion: While preferred stock can sometimes be converted to common stock, the opposite is not possible.
- Voting Rights: Only common stockholders have voting rights, giving them influence in the company.
- Volatility: Common stock is more volatile in terms of share price compared to preferred stock.
- Purpose: Common stock is typically issued to raise capital for various reasons such as expansion or debt repayment, while preferred stock is often used to raise capital without affecting common stock or to meet the demands of venture capitalists.
- Bankruptcy/Liquidation Preferences: In the event of bankruptcy, preferred stockholders have priority over common stockholders for payment.
Share Price
The share price of common stock is subject to greater fluctuations and is widely reported in the news. On the other hand, the share price of preferred stock experiences more gradual growth and is determined by the total amount of dividends divided by the money raised through issuing preferred stock.
Income
Common stock income is primarily derived from capital appreciation, whereas preferred stock income comes from fixed-rate dividends, similar to bonds.
Dividends
Dividends for preferred stock are fixed and paid out before common stock dividends. Common stock dividends, on the other hand, depend on the decisions of the corporation’s board of directors and may be paid out quarterly or whenever declared.
Stock Conversion
While some preferred stocks can be converted to common stock, common stock cannot be converted to preferred stock.
Voting Rights
Only common stockholders possess voting rights, which allow them to influence company decisions. Preferred stockholders do not have voting rights.
Volatility
Common stock is more volatile in terms of share price compared to preferred stock, as it is influenced by daily market forces.
Purpose
Companies issue common stock for various reasons including growth, debt repayment, attracting potential employees, and raising awareness. Preferred stock, on the other hand, is issued to raise capital without affecting common stockholders and is often preferred by venture capitalists for its safer returns.
Bankruptcy/Liquidation Preferences
In the case of bankruptcy, preferred stockholders are paid first before common stockholders, giving them preferential treatment.
When is a Common Stock the Right Choice?
Investors who are comfortable with market fluctuations and seek potential upside in share price, along with voting rights and dividend participation, may choose common stock.
When is a Preferred Stock the Right Choice?
Investors looking for stable dividend income, preferential liquidation status in case of bankruptcy, or protection for their investment may opt for preferred stock. Venture capitalists often prefer this type of stock to ensure payment in case of company failure.
Remember, it’s always a good idea to consult a financial advisor before making investment decisions. If you need assistance, you can connect with financial advisors through platforms like SmartAdvisor by SmartAsset.
Investing in either common or preferred stock grants you fractional ownership in a company, but your returns will vary depending on your choice. Common stock offers potentially higher rewards but comes with more risk, while preferred stock provides safer fixed-income dividends. Make a wise investment decision based on your financial goals and risk tolerance.
The information presented here is created independently from the TIME editorial staff.