What is a Preferred Stock Vs. Common Stock?

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Written By Elizabeth Monroe

Investing in the stock market offers a plethora of opportunities, each with its own set of characteristics and benefits. 

Two primary types of equity investments are preferred stock and common stock, each serving distinct purposes in investor portfolios. 

Understanding the differences between these two is essential for making informed investment decisions. Let’s explore the nuances of preferred stock vs common stock.

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A Closer Look at Preferred Stock 

Preferred stock represents a unique class of equity ownership in a company. Unlike common stock, preferred stockholders typically have a higher claim on dividends and assets in the event of liquidation. 

These dividends are often fixed and paid regularly, providing investors with a stable income stream. 

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Additionally, preferred stock may offer a callable feature, allowing the issuing company to redeem shares at a predetermined price, similar to bonds.

One crucial aspect of preferred stock is its resemblance to hybrid securities, combining attributes of both debt and equity. 

This characteristic appeals to investors seeking a balance between stability and potential returns. 

Moreover, preferred stockholders usually do not possess voting rights in corporate governance, distinguishing them from common shareholders.

Types of Preferred Stock

Prior Preferred Stock: This type holds precedence over common stock but is subordinate to debt holders. It takes priority in dividend payments and asset distribution.

Preference Preferred Stock: Falling behind prior preferred stock, preference preferred stock still holds a higher rank compared to other issuances of preferred stock.

Perpetual Preferred Stock: Unlike some preferred stock with fixed end dates, perpetual preferred stock does not have a redemption date. Investors must sell their shares to realize capital.

Convertible Preferred Stock: Investors may exchange preferred stock for common stock shares, providing flexibility in investment strategies.

Cumulative and Noncumulative Preferred Stock: Cumulative preferred stock ensures unpaid dividends accumulate and must be paid before any other lower-tier shares receive dividends. Noncumulative preferred stock does not carry over unpaid dividends from prior periods.

Participating Preferred Stock: In certain circumstances, participating preferred stockholders may receive additional dividends based on company performance metrics.

Common Stock: Common stock represents traditional equity ownership in a company. Common shareholders have voting rights and may participate in corporate decisions at annual meetings. 

While common stock offers potential for capital appreciation, dividend payments are not guaranteed and are subject to the company’s performance and board decisions.

Unlike preferred stock, common stockholders are last in line to receive assets in the event of liquidation, making common stock riskier in comparison. 

However, common stock often provides higher potential returns due to its association with the company’s growth prospects.

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Key Differences of Preferred Stock Vs. Common Stock Differences

Dividend Priority: Preferred stockholders have priority over common stockholders in dividend payments, often receiving fixed dividends.

Capital Appreciation: Common stock offers higher potential for capital appreciation, while preferred stock focuses on stable dividend income.

Voting Rights: Common shareholders typically have voting rights, whereas preferred shareholders usually do not.

Risk Profile: Preferred stock is generally less risky than common stock due to its fixed dividend payments and higher priority in asset distribution during liquidation.

Advantages of Preferred Stock

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Preferred stock provides stability, regular income, and favorable tax treatment, making it attractive to investors seeking to balance risk and return in their portfolios. Additionally, preferred stock shares similarities with bonds, appealing to income-oriented investors.

An Example of Preferred Stock

Consider a company issuing 7% preferred stock with a $1,000 par value. Investors receive a fixed $70 annual dividend, providing a steady income stream. 

Preferred stock in the financial sector is common, serving as a means to raise capital while offering investors stable returns.

Preferred stock and common stock serve distinct purposes in investor portfolios, offering different risk-return profiles and income potential. 

Understanding these differences is crucial for constructing a well-diversified investment strategy tailored to individual financial goals and risk tolerance.

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