Preferred vs. Common Stock

by James & Miel on September 25, 2009 · 0 comments

The topic of different stock classes, subclasses, qualifications and the like is very complicated topic, but it’s good to know the difference between the two basic classes (especially considering many companies offered a preferred stock purchase program as an employment benefit).

There are two main classes of stock out there, common and preferred, each with its own set of benefits and detriments. Most people are familiar with common stock, whereas preferred stock are subject to its own subset of regulations and carries with it its own subset of benefits, rights, and obligations.

Common Stock
Common stock is what most people are referring to when they talk about buying or selling stock. Purchasing a share of common stock affords the holder a share of the ownership of that company, complete with voting rights when the Board of Directors is to be elected and when certain corporate policies are up for a vote.

Readers: Have any of you voted in a corporate election are shareholders? I usually get a few ballots every year that I fill out (most firms have online voting as well). My vote is certainly statistically insignificant, but it’s one of the few rights you have as a voting share owner, and it’s best to exercise that right.

In addition to the value appreciation of the share, common stock holders can also earn money on their investment through dividends, although there are different dividend payout rules for the holders of common stock than there are for the holders of preferred stock, most notably the fact that dividend payments aren’t guaranteed to holders of common stock.

Common stock is considered a more volatile investment vehicle (as compared to bonds, savings accounts and stuffing your cash in a mattress, that is) but it remains one of the most popular, and colloquially when someone tells you that they bought stock, it is common stock that they are most often referring to.
Preferred Stock
Preferred stock is a different animal than common stock, with certain benefits and rights that make it attractive. The terms of the issuance of a share of preferred stock is spelled out in a document called the “Certificate of Designation”. Those terms are negotiated between the corporation and the shareholders and in reality can encompass any sort of right imaginable.

Most Certificate of Designations, however, cover the same basic set of rights. One of those basic rights is the right to preferential payout treatment during liquidation. This means that in the event that a company is forced to liquidate their assets, preferred stock holders have a higher priority of access to those assets than common stock holders.

Another right that is commonly afforded preferred stock holders is the preferential treatment in the payment of dividends. Often those dividend payments are deferred, but any dividend payment not made is set aside and accumulated until the payout is made.

Preferred stock holders usually have no voting rights (unless explicitly agreed upon in the Certificate of Designation) but the other rights that they are afforded offset the loss in voting privileges. Again, the rights associated with a share of preferred stock are negotiable and vary from corporation to corporation.

Differing Benefits

The main point to remember is both give you ownership of a company and give you the opportunity of wealth creation. Although very similar, common stock and preferred stock offer the shareholder a variety of different benefits.

  • Common stock is mostly used for capital appreciation, dividend payment and company control (the right to vote at shareholder meetings).
  • Preferred stock can also be used for capital appreciation and dividend payment.
  • Preferred stock owners are more likely to receive company assets during a bankruptcy than you would be if you own common stock and your dividend payments are guaranteed.
  • Preferred stocks have a rate of return closer to a corporate bond than common stock (as such, they are less volatile), and are often used as a more conservative, fixed-income investment.
  • Income earned on preferred stock is taxed at the same rate as income, which can mean higher taxes paid on those preferred stock dividend payments.
Readers: Do any readers hold any preferred stock, and if you do, what are your thoughts?
-Michael
Twitter: @michael_DINK