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Those who want to invest in publicly traded companies can easily do so by purchasing shares on the open market. Broadly speaking, stocks give the investor a fractional ownership stake in the company. Meanwhile, companies use the money from stock sales to invest in growth, pay down debt or ramp up their research and development, among other possible uses.
However, there is more than just one type of stock. While most investors buy and sell so-called common stock, companies can also issue preferred stock. And each of these types can be further divided into classes.
Here are the key differences between common and preferred shares.
Common Stock vs. Preferred Stock: How They Compare
Not all stocks are created equal. Common stock and preferred stock are the two types of stock most commonly issued by publicly traded companies, and they each have their own advantages and disadvantages.
Common stock
Common stock is not only common in name; Investors buy this type of stock most often. It grants shareholders ownership rights, allows them to vote on important decisions such as the election of the board of directors, and gives them a say in certain policy decisions and management issues. Each share generally has one vote. Compared to preferred stock, common stock’s earnings potential comes from share price growth over time rather than dividends.
Common stock has greater long-term growth potential than preferred stock, but also has a lower priority for dividends and a payout in the event of a liquidation. Lenders, suppliers and preferred shareholders all line up for a payout before common shareholders. Common stock also has a greater chance of dropping significantly in price than preferred stock.
Common stocks are generally better suited to long-term investors.
Plus points
- Gives voting rights
- There is no limit to how much the stock price can grow
- Taxes on capital gains are deferred until the shares are sold
Cons
- Greater price volatility than preferred shares
- May not receive dividends
- Dividends are paid first on preference shares and then on ordinary shares
- Lower priority than preferred shares to be paid out in a liquidation
Preferred stock
Preferred stock is a type of stock that pays shareholders a certain dividend and has priority over common stock for receiving dividends. Despite the name, preferred stock is not necessarily preferred by most investors (although it does have its advantages).
In many ways, preferred shares are similar to a bond. For example, the main source of return on preferred stock is usually the dividend. Preferred stock is also more likely to provide higher returns than common stock. Like bonds, preferred stocks perform better when interest rates fall. And preferred shares have a par value, that is, a value at which they are issued and which can usually be redeemed when the preferred shares mature.
Preferred stock can also be “called” (that is, redeemed by the company) on a predetermined date. So there is a possibility that the call price could be higher than the price the investor paid. Another unique feature of some types of preferred stock is that they can be converted into a fixed number of common shares. This type of shares is called convertible preference shares.
Preferred stock may be a better investment for short-term investors who don’t have the stomach to hold common stock long enough to ride out price declines. Preferred stocks tend to fluctuate much less than common stocks, although they also have less potential for long-term growth.
Plus points
- Receives a specified dividend that is often higher than regular stock dividends
- Less chance of loss of value
- Has priority over common shares for payment in the event of a liquidation and for receiving dividends
Cons
- Share price growth is generally limited up to the redemption value
- Often does not give voting rights
- The price may fall if interest rates rise significantly
How share classes work
When a company issues common stock, in most cases it issues only one class of common stock. However, in some cases, companies may issue multiple classes of shares, often called Class A, Class B and Class C shares, for example.
Traditionally, Class A shares are publicly traded and carry one vote, just like other types of common stock. Class B shares, on the other hand, may only be available to business owners and executives. In addition, they may have voting rights greater than one vote per share. Finally, Class C shares are very similar to Class A shares, but often do not have voting rights.
Preferred shares can also have different classes. In the case of preferred shares, different classes have different priorities in terms of dividends and payout in the event of a liquidation. But these classes still have priority over common shares. Like bonds, each series of preferred shares has its own dividend, call date and other terms.
How do you buy and sell preferred or common shares?
Investors looking to purchase preferred or common stock will likely do so through a broker. Most online brokers have reduced trading commissions to zero, so you don’t have to worry about high fees to place an order. If you go through a traditional broker, trading costs will likely be higher.
Once you have identified the security you want to buy, you can place a trade for the number of shares you want to buy. Not all companies offer preferred stock, so check what’s available through your broker.
Here are some of the best online stock brokers to buy and sell stocks.
Are preferred shares safer than common shares?
Broadly speaking, preferred stock is less risky than common stock because payments of interest or dividends on preferred stock must be paid before any payment to common shareholders. This means that preferred shares are more important than common shares. But a company’s bonds have a higher priority than preferred stock, so while preferred stock carries less risk than common stock, they do carry more risk than bonds.
In short
If you look at a list of pros and cons for each type of stock, it may seem like preferred stocks are better. While preferred stock has a higher priority for dividends and receiving a payout, this doesn’t necessarily mean preferred stock is better. In general, common stocks have greater long-term growth potential, which means common stocks may be better suited to long-term investors. Which type suits you best depends on your situation.
