Choosing Between Preferred and Common Stock

If you wonder whether you should invest in preferred stock or common stock, you should know that there are some differences when it comes to how each type can be used. First, holders of preferred stock have a greater claim to the earnings and assets of the company. When there is excessive cash to distribute, such as dividends, preferred stockholders benefit more because they are paid before the holders of common stock. In case of insolvency, preferred stockholders are the first in line for the assets of the company. Thus, during liquidation, the company has to pay to all bondholders and creditors, and holders of common stock will not receive anything until the group of preferred shareholders has been paid out. Second, preferred stock comes with more dividends compared to common stock. And if you choose to buy preferred stocks, you will know when to expect payment because dividends are generally paid to stockholders at regular intervals. This cannot be said for common stock. Here, it is the board of directors that determines when dividends are to be paid out. Due to the nature of preferred stocks, they usually do not fluctuate as much as common stock. For this reason, they are also known as a fixed-income security. Dividends are also guaranteed in that if a dividend is not paid out, the company has to pay it before paying other dividends on preferred or common stock. Note that dividends are usually paid in cash, but other stocks and property can also be distributed in the form of dividends.

With common stocks, apart from dividends, capital appreciation is one benefit of holding them. This occurs when the value of stocks goes up over the initial amount that was paid for them. Stockholders can realize profits by selling the stocks. On the other hand, the price of preferred stocks is linked to interest rates. If interest rates fall, their price increases and vise versa.

There are different types of preferred stock to choose from. These include fixed-rate perpetual stocks, convertible preferred stock, adjustable-rate preferred stock, and participating preferred stock. The first variety, the fixed-rate stocks go with no maturity date, with dividend rate being set for the issue’s life. There is a conversion price for convertible preferred stock, and it is named at issuance. Thus, stocks can be converted to common stocks, and a set rate applies. The third variety, adjustable rate stock is also tied to rates, with dividends being paid based on the fluctuations of interest rates. Finally, holders of participating preferred stock are entitled to more dividends if the dividends of common stocks exceed the dividends of preferred stocks.

Common stocks also come in different types. Usually, they entitle holders to one vote for each share owned, but that is not true in all cases. Some companies offer different common stock classes, which are based on the number of votes that go with them. For instance, class A stocks may give stockholders ten votes per share while shares of Class B may go with just one vote. In addition, certain common stock classes will come with no voting rights.

It should be noted that preferred stocks are a less risky investment vehicle than common stocks. These are intended for investors who want to generate income while they also serve to raise capital for the company.