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Preferred Stock Vs Common Stock

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Publish Date: December 05th, 2019

By: Sandhya Kannan, Head – Content

Buying stock in a company in investment parlance refers to buying a share of the company, no matter how small it may be and becoming the part-owner thereof.

Preferred stock and common stock refer to the different kinds of stocks that are issued by companies and are available for purchase.

The Similarities:

  • Preferred stock and common stock, both represent ownership interests in the company.
  • The second commonality is that the price of preferred stock and common stock depend on the earnings of the company. It is market forces and the performance of the company in tandem that decide the prices of these securities.
  • Thirdly, preferred stock and common stock are both used by the company for the purpose of raising funds.

There are many ways in which preferred stock and common stock are dissimilar, and these differences are the reasons why investors may prefer one over the other.

The Dissimilarities:

  • Preferred stockholders do not have voting rights and common stockholders have voting rights. The management of the company may issue preference shares when they wish to raise funds without diluting the present voting arrangements.
  • In case of a company defaulting on its dues, the preferred stockholders have a preferential payback of dues versus the common stockholder. In order of payment, they lie after the creditors, but before the common stockholders.
  • Dividends are another point of difference. Preference stocks are issued with assured dividend percentage which has been 9% or 6% by various companies. Common stocks receive a dividend based on surplus funds available with the company and its distribution as decided by the board of directors. In this respect, it is useful to note - even though preference stocks are assured a dividend, the board of directors does have the right to defer payment in times of cash shortage. This is how they differ from bonds – as the company is not in default on deferral of promised dividend.
  • Types of preferred stocks. The preferred stocks issued may be redeemable, cumulative or convertible preferred stocks. Redeemable preferred stock is redeemed by the company at the fixed maturity date. Cumulative preference shares accumulate the dividend paid and pay it back together at the time of maturity. Convertible preference stocks give the stockholder the right to convert the preferred stocks into common stocks at maturity. In comparison, common stock is common stock – there are no categories to it.
  • The value at maturity is a point of difference as well. The preferred stock receives a set upon amount at maturity which is fixed and common stock receives the value which is variable and depends on the performance of the company and the market prices at the time of selling the stock.
  • Common stock can yield much higher returns than preferred stocks but are also much riskier.

Companies may issue preferred stocks when they want to raise capital without management interference. The payouts to preferred stockholders are not tax-deductible, so they are not usually preferred to bonds by companies.