Stock is basically an ownership stake of a company based on the amount of shares a stockholder has. Companies issue stock in order to get money to do various things. They raise capital in order to pay debts, open new facilities, create new products, etc.
There are basically two types of stock, common and preferred stock. There is a baked in level of risk when dealing with stocks since you cannot predict the market. However, a preferred stock may offer less of a risk of loss than a common stock. Let’s review the details of each and walk through the differences.
What Is A Common Stock?
Common stock is basically a share in a company that qualifies the stockholder for dividends based upon how well the company is doing financially. If the company is not doing great, it is possible that the stockholder may not be paid out dividends.
Common stocks are bought and sold on a stock exchange during the day. The prices of the individual stocks fluctuate based on demand for the stock. Pricing can be influenced by many factors, such as a company’s earnings, health of the economy, and any recent public relations announcements.
There are many benefits of common stocks. There is a great chance to make capital gains over long term investments. They allow their shareholders to vote on corporate issues, the more stock you have the greater your voice is. Also, you get an insight into the company’s financial status via a detailed report.
What Is A Preferred Stock?
Preferred stocks have qualities of both common stocks and bonds, and are therefore considered a hybrid of the two. The preferred stock combines the equity ownership advantages of common stock in addition to the income producing capabilities of bonds.
There are a few different kinds of stocks for which preferred stocks fall into — namely income stocks, growth stocks, value stocks or blue-chip stocks. Each of these have their own unique characteristics and come with their own risks or potential rewards.
Dividends are a huge plus when talking about preferred stocks. You are not guaranteed to receive dividends with preferred stocks, but you do have much higher dividend security than with common stocks. Dividends can be paid out cumulatively or non-cumulatively, which depends on the particular company and how it is doing financially.
Common vs. Preferred Stock Comparison
Common and preferred stocks have similarities when it comes to having an ownership stake in a company, or when talking about the cost basis for the security. Outside of this, the two kinds of stocks have many different unique characteristics.
Do you have a say in the company? Are you able to help make a decision that is weighted depending on the amount of shares you have? If there is a takeover bid or board of directors, or other corporate issues — will you be able to assist in the decision making process with these types of stocks?
- Common Stock: Yes, you will have a vote (more shares you have, the more you have a voice in the decision)
- Preferred Stock: No, you do not have a vote as you do with common stocks
Dividends are an important part of stocks in general. When investing, people typically like to get frequent returns on their investments. Both common and preferred stocks pay dividends, but they differ in how they work.
- Common Stock: Varies depending on how profitable the company is that you have invested in
- Preferred Stock: Fixed dividend amounts at regular intervals (similar to a bond)
Value If Held To Maturity
The stock market can be volatile at times. There are usually no promises when it comes to earnings on your investments. The closest you will come is if a stock reaches maturity, and that is where these types differ.
- Common Stock: Varies on the stock market and company performance (if a company underperforms or goes bankrupt, you will receive nothing)
- Preferred Stock: Full value on initial investment if you hold preferred stocks until maturity (similar to bonds)
Order Paid If Company Goes Under
There is a priority for whom gets paid if a particular company is about to go bankrupt, or in the process of liquidation. The first in line to receive assets are bondholders. Next comes the stockholders, with you guessed it — preferred stockholders getting the priority over common stockholders.
- Common Stock: In the order of payment, they are third in line behind Bonds and then Preferred Stocks
- Preferred Stock: In the order of payment, they are second in line after Bonds
Ownership Of The Company
A stock definition is as such — a type of security that provides shares of ownership for a company by its stockholders. Stocks primarily come in two types, common and preferred stocks. By definition, you have a share of ownership when you have either type of stock.
- Common Stock: Yes, if you own stock in a company, you have a share of ownership
- Preferred Stock: Yes, if you own stock in a company, you have a share of ownership
Basis For Price Of Security
The basis for a securities price is based simply on the company’s earnings. This holds true for both common and preferred stocks.
- Common Stock: The basis of the stock price is based off of the stock market earnings
- Preferred Stock: The basis of the stock price is based off of the stock market earnings
Is there an upside with both common and preferred stocks? With common stock, if a company is performing above expectations, you may actually see greater returns than with preferred stocks that may have a cap.
- Common Stock: Somewhat unlimited potential based on how well a company is doing
- Preferred Stock: You are limited to the redemption value with preferred stocks (except for convertible preferred stock)
When investors search for stocks that offer a more secure dividend with a lower risk of loss, they would choose (or prefer, if you will) preferred stocks. There is always risk with stocks and the market, but there are better safeguards when dealing with preferred stocks.
- Common Stock: There is a risk that the stock value could possibly drops to $0, essentially losing that entire investment
- Preferred Stock: It is possible that it drops to $0, though it is less likely to do so given the priority repayment structure if something goes wrong with the company
Consider Guidance From A Financial Advisor
Whether you are early in your investing career, or closer to the middle or end, you should be conscientious of the types of investments you are making. You may be willing to take on more risk if you want to reap more rewards, or perhaps you want a safer or consistent dividend payout. If you aren’t sure exactly what the differences are still, or have any lingering questions about common or preferred stocks, perhaps you should contact a financial advisor.