Preferred vs. Common Stock: What's the Difference?

Preferred vs. Common Stock: An Overview

There are many differences between preferred and common stock. The main difference is that preferred stock usually does not give shareholders voting rights, while common or ordinary stock does, usually at one vote per share owned. Many investors know more about common stock than they do about preferred stock.

Both types of stock represent a piece of ownership in a company, and both are tools investors can use to try to profit from the future successes of the business.

Preferred Stock

One main difference from common stock is that preferred stock comes with no voting rights. So when it comes time for a company to elect a board of directors or vote on any form of corporate policy, preferred shareholders have no voice about the future of the company. In fact, preferred stock functions similarly to bonds in terms of yield, since with preferred shares, investors are usually guaranteed a fixed dividend in perpetuity when bond holders receive coupons until bond maturity. However, in case of bankruptcy or liquidation, bondolders are more senior in the list of stakeholders to be paid. This means, they are paid first before preferred shareholders.

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.

In a liquidation, preferred stockholders have a greater claim to a company's assets and earnings. This is true during the company's good times when the company has excess cash and decides to distribute money to investors through dividends. The dividends for this type of stock are usually higher than those issued for common stock. Preferred stock also gets priority over common stock, so if a company misses a dividend payment, it must first pay any arrears to preferred shareholders before paying out common shareholders.

Unlike common shares, preferreds also have a callability feature which gives the issuer the right to redeem the shares from the market after a predetermined time. 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.

Common Stock

Common stock represents shares of ownership in a corporation and the type of stock in which most people invest. When people talk about stocks, they are usually referring to common stock. In fact, the great majority of stock is issued in this form.

Common shares represent a claim on profits (dividends) and confer voting rights. Investors most often get one vote per share owned to elect board members who oversee the major decisions made by management. Stockholders thus have the ability to exercise control over corporate policy and management issues compared to preferred shareholders.

Common stock tends to outperform bonds and preferred shares. It is also the type of stock that provides the biggest potential for long-term gains. If a company does well, the value of a common stock can go up. But keep in mind, if the company does poorly, the stock's value will also go down.

Preferred shares can be converted to a fixed number of common shares, but common shares don't have this benefit.

When it comes to a company's dividends, the company's board of directors will decide whether or not to pay out a dividend to common stockholders. If a company misses a dividend, the common stockholder gets bumped back for a preferred stockholder, meaning paying the latter is a higher priority for the company.

The claim over a company's income and earnings is most important during times of insolvency. Common stockholders are last in line for the company's assets. This means that when the company must liquidate and pay all creditors and bondholders, common stockholders will not receive any money until after the preferred shareholders are paid out.