Written by Norman Isaac Mwambazi

Preferred and Common stock: What is the difference?

At this point, I do not think I need to define what stock is but since I am a nice …

At this point, I do not think I need to define what stock is but since I am a nice guy, let me briefly explain it. Stock is simply a fraction of the company. When you buy a company’s shares of stock, you are owning part of the company, however small it may be. This means that you have the possibility of enjoying that company’s growth in profits without even working for the company. Talk about having your money working for you.  

There are mainly two types of stocks namely; Common stock and preferred stock.

Common stock

Just as the word says, common stock is common. This is the type of stock in which most people invest. People are referring to common stock whenever they are talking about common stock. This is the type of stock that publicly-traded companies issue out the most.

Common stockholders may or may not get dividends from the company, but they are guaranteed voting rights when the company is electing board members. Usually, common stockholders get one vote per share owned so the more shares you own in the company the more influence and powerful your vote will be and the reverse is true.

The voting rights stockholders own mean they can exercise control over a company’s corporate policy and management issues, something preferred shareholders cannot do.

Although investors who own common stock are not guaranteed of fixed dividends, the common stock tends to outperform bonds and preferred shares in the long-term for it provides the biggest potential.

Common stock appreciates if a company performs well and it depreciates if the company underperforms. In simple terms, the value of a common stock is controlled by the demand and supply of the market participants.

In case a company gets to a point where it has to be liquidated, investors owning common stocks will not be paid until creditors, bondholders and those owning preferred stock are paid.

Preferred Stock

Contrary to its name, preferred stock is the less preferred stock for investors, mostly because it does not come with voting rights to the owner. This means that a preferred stock owner does not have any say in the way the company is being managed, its corporate policy, or any decisions undertaken, even when they may own a billion shares.

The upside of owning preferred stock though is that owners are entitled to fixed dividends permanently quarterly, or monthly, or semi-annually depending on when the company decides to pay them out.

Another upside about preferred stock is that when a company decides to be liquidated, owners of this kind of stock will be paid before those who own common stock are paid. Just like bonds, the value of preferred stocks is affected by interest rates in the economy in that if interest rates rise, the value of the preferred stock declines and the reverse is true. 

It is also important to note that shareholders of preferred stock receive higher dividends than common stockholders. Preferred stock can also be called back from the market after a predetermined time. This means that the company can buy these shares back at any time for any reason but for a premium over their purchase price.

Summary

  • Both common stock and preferred stock give investors some degree of ownership of the company.
  • A common stock gives investors voting rights on a one vote per share basis whereas preferred stock does not.
  • Preferred stock owners are guaranteed to get fixed dividends from the company in perpetuity whereas, for common stockholders, the company may or may not give them dividends.
  • Common stock is more valuable in the long term than preferred stock.
  • Common stock is the type that companies issue out the most, and it is the most invested in.
  • Preferred stock can be turned into common stock but you cannot turn common stock into preferred stock.
  • The company can buy the preferred stock back from shareholders. 
  • In case the company goes liquid, preferred shareholders are paid before common stockholders can be paid.