Common Stock vs. Preferred Stock

When setting up most types of corporations you have an option as to the difference classes of stock that you can set up, with many large companies having as many as a dozen difference classes of stock. Common stock and preferred stock are the two main types of stock that companies will use and many different features and terms can be assigned to each. This article will provide you with a background on how to understand the difference between common stock vs. preferred stock.

Common Stock

Common stock represents the most common type of stock issues by companies and entitles shareholders to participate in the profit and growth of the company they invest in. When looking at investing in the stock market for the most part you are buying common shares in a company.
The two main income drivers for common stock are that they deliver appreciation (through growth in value of the company) and through dividends paid out of the company to shareholders. Dividend payments can change over time so predicting cash flows through common stock holdings can be difficult.

Common stock are typically voting and allow holders to ‘vote' on issues like electing the board of directors or other issues put to a vote. This is not always the case, however, so it may be important to refer to the specific features of a class of shares you are investing in.

Holding common stock also comes with ‘pre-emptive rights' to maintain the same proportion of ownership should a company issue a new stock offering. This means that holding common stock will entitle you to pre-emptively buy new shares should the company be completing an issuance.

Preferred Stock

The value and returns of preferred stock can vary greatly depending on the features and terms that are applied to them. Preferred stock often does not have voting rights and do not provide an ability to participate in the appreciation in the value of the company. Often, they come with specific payment terms that take precedence over common stock, with say a set dividend being paid out monthly, quarterly, or annually.

Preferred stockholders typically have first access when it comes to dividends and also in a bankruptcy situation, where after creditors are paid preferred stockholders will be compensated before common shareholders. Preferred stock can also have set redemption terms, where a holder can have them redeemed at a favorable price for either cash or sometimes even common shares.

The key issue with preferred stock is that every feature discussed above came with an ‘often' or ‘can' caveat. Preferred stock terms can vary greatly so it's important to read the fine print in terms of exactly the class of shares is treated before actually investing in them. In some companies preferred shares still have many of the features of common shares, i.e. voting and holding appreciation value, so nothing is set in stone in terms of what preferred stock can do.

Common Stock vs. Preferred Shares

Often the decision between investing in common shares vs. preferred stock comes down to a risk and reward relationship. Common stock is riskier, you may lose it all, but often provides a better chance to participate in the growth of a successful company. Preferred stock come with less risk (assuming they have preference rights over common shares) but come with set dividend and repayment terms. Ultimately the choice comes down to weighing the risks and what your opinion is on the future of the company being considered.
By Jeffrey Glen

Copyrighted 2020. Content published with author's permission.

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