What Are Different Types of Stocks: Common vs Preferred

Investing in the stock market is one of the best ways to build and grow wealth in the long run. After deciding to invest in the stock market, the next decision you will have to make is to choose the type of stock you want to invest in. The two types of stocks that you choose from are common stocks and preferred stocks.

These stock categories imply that some stocks are geared towards growth and wealth creation in the long run, whereas others are geared towards stability and regular income. In this blog, we will understand the meaning and difference between common and preferred stock.

What Are Common Stocks?

Common stocks are shares that represent ownership in a company that is listed on a stock exchange. By purchasing a common stock, you will be a partial owner of that company, which means that you will be able to enjoy its growth and prosperity. Here are the key features of common stocks you must know:

Shareholding in the Company: You are a shareholder in the company. This ownership provides you with a claim on the assets and profits of the company, but it will be second to creditors and preferred shareholders.
Voting Rights: The majority of common stockholders are allowed to vote on significant corporate matters, such as the election of the board of directors or the acceptance of significant changes.
Variable Dividends: Dividends on common stocks are not fixed. They rely on the profits of the company and the decisions of the board.
Potential Capital Appreciation: Common stocks can appreciate as time goes by. Your shares may be worth much more in case the company develops and becomes successful.

Benefits of Common Stocks

Here are the key benefits of common stocks you must know:

Ownership and Voting Rights: The common shareholders are the partial owners of the company, and they have the capacity to vote on the corporate decisions, including the board elections or mergers.
High Growth Potential: Common shares have high capital appreciation. As the company expands and becomes more profitable, your shares may be worth a lot more in the long run.
Dividend Participation: Even though dividends are not assured, the common shareholders will share the profits of the company in the event of dividend declaration.
Liquidity: The common shares are traded in stock markets readily and are therefore easy to buy and sell. It allows investors and traders to enter or exit positions fast.
Inflation Hedge: The long-run returns of common stocks have historically been higher than inflation, which is why they are an excellent instrument of wealth creation and maintenance of purchasing power.

Disadvantages of Common Shares

Here are all the cons of common stocks you must consider when investing:

Dividend Uncertainty: Common stock dividends are not fixed and are subject to change. When a firm experiences a poor year, it can cut or freeze dividends.
Higher Volatility: The prices of ordinary shares vary largely depending on the market mood, the economy and the performance of the company. This renders them riskier, particularly in the short run.
Preferential Treatment in Liquidation: Common shareholders are paid last after creditors and preferred shareholders in the case of bankruptcy or liquidation. It implies that the invested capital is at a greater risk of being lost.
Requires Active Monitoring: Due to volatility and market-driven factors, investors should be aware of company performance and market trends.

Common stocks are riskier than preferred stocks. The prices are not fixed, and the dividends are not assured. However, common stocks have better long-term growth potential for those investors who are prepared to ride the highs and lows.

What Are Preferred Stocks?

Preferred stocks, also called preference shares, are hybrid securities with a combination of both stocks and fixed income. They are aimed at the investor seeking stability and predictable income instead of the high growth potential of common stocks. Here is what makes preferred stocks special:

Fixed Dividends: Preferred stocks typically pay a fixed dividend, which provides predictable income as opposed to common stocks.
Preference in Dividends and Liquidation: Preferred shareholders receive payment prior to the common stockholders. They are given priority in the company assets in case of liquidation.
Limited or No Voting Rights: Preferred stocks are usually not accompanied by voting rights, and thus, they provide stability in terms of income rather than control.

Benefits of Preferred Stocks

Here are all the benefits of preferred stocks you must know:

Constant Revenue: Preferred shares are fixed dividend-paying shares that offer consistent income. This makes them a good investment option for investors who want to get a consistent cash flow.
Priority on Dividends: Preferred shareholders receive payments before the common shareholders, which makes them more reliable in terms of the distribution of income, even in case the profits of the company vary.
Higher Claim on Assets: Preferred shareholders are given priority over common shareholders in the distribution of assets in case of company liquidation, but they are still after the debt holders.
Lower Price Volatility: Preferred stocks are less likely to change price, as compared to common shares. They are more stable with their bond-like characteristics, which attract risk-averse investors.

Certain preferred shares can be converted to common shares, which provides a possibility of capital growth, but at the same time, they offer a stable income. Others are cumulative, i.e. missed dividends are accumulated and are to be paid later.

Disadvantages of Preferred Stocks

Limited Growth Potential: Preferred stocks do not gain much when the company grows as compared to common shares. The growth in capital is capped, and thus the growth in the upside is capped.
Minimal or No Voting Rights: The majority of preference shares do not have voting rights, and hence, investors do not have much influence in corporate decision-making.
Interest Rate Sensitivity: Since preferred shares are more or less like bonds, they are sensitive to changes in interest rates. The market value of preferred shares can be decreased by increasing interest rates.
Callable Feature Risks: Certain preferred shares are callable, i.e. the company in which they are issued can repurchase them at a specified price, which can restrict the amount of profit that investors can get.
Less Flexible Dividends: The fixed dividends might not rise even when the earnings of the company are significantly high. This can be restrictive to investors who want to have increasing sources of income.

Common Stocks vs Preferred Stocks: Key Differences

Here are the key differences between common stocks vs preferred stocks you must consider before investing in the stock market as a beginner:

Things to Consider when Choosing Between Common vs Preferred Stock

Prior to investing, it is important to remember a few things:

Stability of Dividends vs Growth Potential: Preferred stocks are fixed dividend-paying stocks, but they do not tend to appreciate greatly over time, as is the case with common stocks.
Limited or No Voting Rights: The majority of preferred stocks are associated with minimal or no voting rights. This implies that you will not participate in the decision-making of the company, as is the case with common stockholders.
Priority in Payments: Preference shares are less risky as compared to common stocks, particularly in periods of financial decline.
Interest Rate Sensitivity: Preferred stock prices may act as bonds. The value of the existing preferred shares can decline when interest rates increase, and the opposite is also true.
Types of Preferred Stocks: Certain preferred shares have special characteristics:
- Cumulative preferred stock: Missed dividends are accumulated and paid off in the future.
- Convertible preferred stock: It can be converted into common shares, which provides a possible growth.
- Callable preferred stock: The company can repurchase shares at a predetermined price, which can reduce upside.

Preferred stocks are the best option when you desire to have a stable income, reduced risk, and a higher dividend priority. However, they are not very influential and do not normally give voting rights.

Conclusion

The first step in investing in the stock market is to know the types of stocks and their characteristics. The two general types that we have discussed, common stocks and preferred stocks, are used for different purposes and are applicable to different investment objectives. Common stocks are less risky, have high growth potential, and voting rights, but have fluctuating dividends.

Preferred stocks are concentrated on predictable and stable income, dividend and liquidation priority, and reduced volatility, but they tend to lack voting rights and high growth potential. Understanding the difference between common and preferred stock will allow you to make wiser investment choices.