Common and Preferred Stock

‘Stock’, a term used to denote securities that carry ownership interest and reflect potential claim
on the assets and income, earned by the corporation. It is classified into two broad categories,
i.e. common stock and preferred stock. The former implies the ordinary stock issued by the
companies, while the latter, are the ones that carry preferential rights regarding dividend
payment and repayment of capital.

Stock indicates, the net worth or shareholder’s equity, of the firm, which can be arrived by
deducting total liabilities from total assets. The investors who contribute money through stocks
are known as stockholders.

If you are a novice to the stock market and have no idea about the classes of stock, then this
article might prove helpful to start your investment journey. So, to make a rational decision
regarding investment in any of the two, all you need to know is the difference between common
and preferred stock.

Content: Common Stock Vs Preferred Stock

1. Comparison Chart
2. Definition
3. Key Differences
4. Conclusion

BASIS FOR
COMMON STOCK PREFERRED STOCK
COMPARISON

Meaning Common stock refers to the ordinary stock, Preferred stock, represents that part
representing part ownership and confers capital that carry preferential right, to b
voting rights to the person holding it. the company goes bankrupt or wound u

Growth potential High Low

Rights Differential Rights Preferential Rights

Return on capital Not guaranteed. Guaranteed and that too, at a fixed rate
 BASIS FOR
COMMON STOCK PREFERRED STOCK
COMPARISON

Partipation in Entitles a person to participate and vote in Does not entitles a person to participat
elections the company's meeting. the company's meeting.

Repayment priority Payment to common stockholders are made Preferred stockholders are paid bef
at the end. stockholders.

Redemption Cannot be redeemed Can be redeemed

Conversion Not possible Possible

Arrears of dividend They are not entitled to arrears of dividend, They are entitled to arrears of dividen
if skipped in the previous year. in the previous year.

Definition of Common Stock

Common stock is what most people think of when they think "stock." Common stock allows its
holders to make a profit through rising share prices and dividend payments. Holders of common
stock also get to vote on corporate issues, such as electing new directors to the corporation's
board. However, should the company end up in bankruptcy, holders of common stock are last on
the list to get their money back -- after regular creditors, bondholders, and holders of preferred
stock. If you hold common stock and the company goes bust, you are unlikely to get any of your
capital back.

Common Stock represents the owner’s fund, as equity shareholders jointly own the company.
The stockholders are entitled to both risk and rewards of ownership, but their liability is limited
to the capital contributed by them.

In general, a publicly traded company issues common stock to raise funds, at a price, the market
is willing to pay. The investment value of such stocks goes up irregularly but persistently, over
the years, because of the reinvestment of undistributed earnings, builds up the net worth.
Although, they face a considerable amount of fluctuations in price, due to speculation. The rights
of common stockholders are discussed below:

 Right to Income: Common stockholders have a residual claim on the earnings of the
firm.
 Right to Vote: Common stockholders, has the right to elect firm’s board of directors and
vote on various corporate policies, at the general meeting.
 Pre-emptive Right: The pre-emptive rights allows the existing stockholders to buy the
company’s stock before they are publicly available, so as to maintain their proportional
ownership.
 Right in Liquidation: Common Stockholders are entitled to receive the leftover amount
and assets of the firm in the event of liquidation, i.e. once all the creditors, debenture
holders, preferred stockholders are paid off, the amount and assets remained are
distributed to common stockholders in the ratio of their ownership in the company.

Definition of Preferred Stock

Preferred stock also represents owning a share of the company, but it works a bit differently than
common stock. Preferred stock pays a predetermined dividend, whereas the dividends paid to
common shareholders tend to vary according to the company's fortunes. Dividends on preferred
stock are often larger than those on either common stock or the company's bonds. Holders of
preferred stock do not get a vote on company matters. And if a company's assets are liquidated,
the preferred stockholders get to redeem their shares before common stockholders do, giving
them a better chance of getting at least some of their money back. 

Preferred Stock implies a class of security, which do not carry voting rights but have a higher
claim on the company’s assets and income. Preference stockholders enjoy preference in certain
matters, as to the payment of the fixed amount of dividend and repayment of capital in the event
of liquidation or bankruptcy. It is a fixed income-bearing investment vehicle, which may or may
not have a maturity period.

Preferred Stock is the hybrid form of security, that imbibes features of common stock and debt,
in the sense that they carry a fixed rate of dividend, which should be paid only out of
distributable profit. Further, the nature of dividend is cumulative, in essence, that if the payment
of dividend is skipped in a particular year, then the dividend is carried forward to next year and
arrears of dividend has to be paid by the company. If the payment of dividend is not made
consistently for three years, then stockholders become eligible to vote at the general meeting.
Benefits and drawbacks
Preferred stock generally pays a higher dividend than common stock, but in certain
circumstances this can change. Because preferred stock dividends are set at the time the stock is
issued, if the company should decide to issue a larger dividend than it originally planned, the
dividends on common stock will go up (and can rise above those for preferred stock), but the
dividends on preferred stock will not.
In some ways, preferred stock is like a cross between a bond and common stock. Preferred
stockholders get some of the best of both types of investments, but they also get the drawbacks.
Preferred stock is typically far more volatile than a bond -- in fact, it can be nearly as volatile as
common stock, though its fixed dividends lend it a bit more stability. And shares of preferred
stock, like bonds, are sometimes callable, meaning that the corporation has the right to buy back
those shares at a set price any time it chooses.
The voting rights that holders of common stock enjoy are generally of little benefit unless you
own a significant percentage of the company's stock. While the dividends are typically lower
than those paid by preferred stock shares, the value of common stock tends to rise more quickly
than the value of preferred stock when the company thrives (and fall faster when the company
runs into trouble).
Which is better?
For most investors, common stock is a better deal. It's slightly riskier than preferred stock, but
will usually show a slightly higher return as well. If you want to enjoy the potentially high
returns of a stock investment but want to minimize your investment's volatility or your exposure
to company-specific risk, preferred stock might be a better choice. Preferred stock may also be
better if you're looking for a source of income you can depend on, as the dividends paid on such
stock are fixed. But whichever class of stock you choose, be sure that it's an investment you'll
feel comfortable holding over the long haul.

Key Differences Between Common and Preferred Stock

The difference between common and preferred stock are discussed in detail, in the points given
below:

1. Common Stock, implies the type of stock ordinarily issued by the company to raise
capital, indicating part ownership and carry voting rights. Preferred Stock is that class of
stock, which gets priority regarding the payment of dividend and repayment of capital.

2. Common Stock has high growth potential, as compared to preferred stock, whose
propensity to grow is slightly low.

3. Common Stockholders return on capital is neither guaranteed, nor the amount is fixed.
Unlike preferred stockholders, whose return is guaranteed and that also at a fixed rate.
4. Common Stock carries differential rights regarding voting, dividend and repayment of
capital. On the other hand, the preferred stock holds preferential rights as to the dividend
and capital repayment.
5. Common stock entitles a person to participate and votes in the company’s general
meeting. As against this, preferred stock does not allow a person to participate and vote
in the company’s general meeting.
6. Common Stock can never be redeemed by the company. Conversely, preferred stock is
redeemed by the company, either on their maturity or when the company wants to buy
back.
7. Common Stock cannot be converted into any other security, whereas preferred stock can
easily be converted into common stock or debt.
8. Common stockholders are not entitled to an arrear of dividend, if not paid by the
company in the previous year, due to insufficient funds. On the flip side, preferred
stockholders are entitled to arrears of dividend, if it is skipped in the previous year, or
else they acquire voting rights if the company skips dividend payment for three
consecutive years.