Anyone with a mediocre knowledge of investing will be familiar with the term “stock”.
But few people are aware that there are common stocks and preferred stocks. And they’re fundamentally different.
Stocks have been traded for over 400 years – the first common stocks were made available in 1602 through the Dutch East India Company. They form the building blocks of our modern-day economy and have taken on personalities of their own.
In a nutshell, here’s what we need to be clear about when it comes to working with preferred stocks and common stocks.
Both represent a piece of ownership in a company, and both are tools that we can use to try and profit from the company’s future successes. The differences come down to what privileges or rights we will enjoy and how risky our investments are.
The first key difference is in voting rights. Preferred stock owners do not have any say in how the company is run, whereas common stock owners enjoy voting rights. This is most often one vote per share-owned and allows a say in concerns like the election of board members who oversee management’s major decisions. Common stockholders can influence corporate policy and management decisions where preferred shareholders do not.
While they may have less say in the company direction and management, preferred shareholders have priority over a company’s income and are paid dividends before common shareholders. This offers slightly more investment security and predictability when a company performs poorly, as dividends are generally paid out more regularly and aren’t always paid out to common stockholders. In times of liquidation, the preferred shareholders have first dibs on assets and earnings.
Common stockholders are last in line when it comes to company assets, which means they will be paid out after creditors, bondholders, and preferred shareholders. In this way, preferred stocks are very similar to bonds.
The payoff for common stockholders (the most popular form of stock allocation) is that the gains can be significantly higher in the long term if the company grows and finds a solid footing in the market as a profitable entity. They may not reap the rewards of dividends in the early days, but they stand to reap more in the long term.
Depending on your personal investment strategy and event horizons, it may be worth considering preferred stocks over common stocks or vice versa. It’s good to remember that preferred stocks can be converted into common stocks, but we can’t go in the other direction.