Stock ownership is a foundational way companies raise capital. Two main types exist: common stock and preferred stock, each suited to different investor needs. Common stockholders have ownership rights including voting privileges on company matters, and their dividends fluctuate based on company profitability. Preferred stockholders receive fixed dividends paid before common shareholders and have priority in asset claims if the company liquidates, though they typically lack voting rights.
Background and History
Companies have issued common stock since the origins of equity markets, giving investors ownership shares and a voice in corporate governance. Preferred stock emerged later to combine equity ownership with fixed-income characteristics, appealing to investors seeking more reliable income and higher priority during financial distress.
How Common Stock Works
Owning common stock means partial ownership in a company. Shareholders usually get one vote per share to elect directors and influence key decisions. Dividends on common stock vary and are not guaranteed, reflecting the company’s earnings. Investors also benefit from capital gains if stock prices rise. However, in bankruptcies, common shareholders are last to be compensated after creditors and preferred shareholders.
How Preferred Stock Works
Preferred stockholders receive fixed dividends before any payments to common shareholders, providing more consistent income. Generally, preferred shares do not carry voting rights, offering less influence in company decisions. In liquidation scenarios, preferred shareholders have priority over common stockholders but are subordinate to debt holders. Some preferred stocks are convertible, allowing holders to exchange preferred shares for common stock under certain conditions.
Real-World Examples
Consider two companies: Company A issues common stock, providing voting power and dividends that can fluctuate with profits. Company B issues preferred stock offering stable dividend payments but no voting rights. If Company B faces financial troubles, preferred shareholders receive dividends first and have a higher claim on assets than common shareholders.
Who Benefits and When
Common stock appeals to investors focused on growth and willing to take more risk for potential capital gains. Preferred stock suits those seeking predictable income with lower risk, such as retirees or income-focused portfolios. Preferred shares are common among utilities, banks, and firms with steady earnings.
Investor Tips
- Choose common stock for voting rights and growth potential.
- Opt for preferred stock if steady income is your priority.
- Diversify holdings between the two to balance risk and return.
- Check if preferred shares are convertible for added flexibility.
Detailed Comparison Table
| Feature | Common Stock | Preferred Stock |
|---|---|---|
| Voting Rights | Usually one vote per share | Typically none |
| Dividend Payments | Variable, not guaranteed | Fixed, priority over common |
| Asset Claims | Last after creditors & preferred | Priority over common shareholders |
| Price Volatility | Higher | Lower |
| Growth Potential | High (capital gains) | Limited (fixed income style) |
| Convertibility | No | Sometimes convertible |
| Ideal Investors | Growth-focused, risk tolerant | Income-focused, risk-averse |
Common Misconceptions
- Preferred stock is not as safe as bonds; it still carries equity risk.
- Dividends on preferred stock can be deferred in extreme cases.
- Voting is generally reserved for common shareholders.
FAQs
Can I own both types of stock in one company? Yes, if the company issues both kinds.
Which pays higher dividends? Preferred stock generally pays higher, fixed dividends.
Are preferred dividends guaranteed? No, but missed dividends for cumulative preferred stock must usually be paid later.
Which stock is better for growth? Common stock typically offers superior growth potential.
References
For more detailed information, see IRS resources on investing and dividend taxation or consult the Investor.gov Basics.
Understanding the differences between common and preferred stock helps you make informed investment decisions aligned with your financial goals by weighing income needs against growth and control priorities.