To raise money by sharing stocks in a business can be done by either preferred stock or common stock. Preferred stock and Common stock, both represent a shred of ownership in a company as well as both are tool investors. Though there are many differences between the two terms. The investors who want to invest in stocks should definitely know the differences.
Preferred vs Common Stock
The main difference between the preferred stock and common stock is that the preferred stock dont allow the shareholder to the voting rights while in common stock the shareholders have the voting right. Also, another difference is that the firm is obliged to pay dividends in the preferred stock while they are not in the common stock.
Preferred stocks are stock that entitles the holder to a fixed dividend. The shareholders have priority over a company’s income. They are most likely the paid dividends. Preferred stock shareholders dont have the rights to any decision made by the firm through voting about any corporate policy.
Common Stock is corporate equity ownership. This stock gives the right to the stockholder to share the profits of the company. It also allows voting on matters of corporate policy or decisions about the board of directors. The common stock owners dont own particular assets of the company, they belong to all the shareholders in common.
Comparison Table Between Preferred And Common Stock
| Parameters of Comparison | Preferred Stock | Common Stock |
| Voting Rights | The stockholders usually don’t have voting rights. | The stockholders have voting rights. |
| Liquidity | The liquidity is low. | The liquidity is high. |
| Fixed Dividend | There is a fixed dividend. | No fixed dividend. |
| Price | Preferred stocks are usually sold at a higher price. | Common stocks are sold at market value. |
| Risks | Less exposed to the risks. | More exposed to risks of the business. |
What is Preferred Stock?
Preferred stocks are also known as preferred shares or preference shares. It is a component of capital stock. These stocks entitle the stockholder to a fixed dividend. The preferred stockholders are given more priority, they have a higher dividend yield. Also, they need to be repaid as a priority before any other beholders, if a company goes bankrupt. They are given higher claims to the assets or profits of the company.
The preferred stocks are usually sold at a higher price. The advantage of the stock is that the cash inflow is highly predictable and the firm is obliged to pay the dividends. They also have the advantage that the issuer has the right to redeem the shares after a predetermined time, from the market. And the preferred stock is not much exposed to the risks of the business. There is a lower risk of loss.
Though, the preferred stock shareholders have no right to vote in the decisions making of the firm related to the corporate policies, mergers, or the board of directors. They are rarely given control. And the disadvantage is that the preferred shareholders are given a limited potential for capital gains. Also, preferred stock shares are affected by interest rates, if the interest rate rises the value of the stock will decline.
What is Common Stock?
Common Stock is corporate equity ownership, which gives the right to the stockholder to share the assets or profits of the company. Though, the common stock investors don’t own any particular assets in the company. It gives the investors an ownership stake in the corporation. Common stocks are usually sold at market value. Common stocks are also known as equity shares, voting shares, and ordinary shares.
Common stock allows the shareholder to vote on matters of the firm, in the decision-making. The investors get one vote per share, which means they have a say and control over corporate policy, merges, and management issues. The common stock is more exposed to the risks of the business. So, it dramatically raises the value over time as the company grows bigger which leads to more profits. It takes years.
The advantage of common stock is that it provides unlimited upside potential from capital gains. The disadvantage is when, in liquidation, the common stockholders are paid the fund in the last after the bondholders and preferred stockholders. If the company goes bankrupt, they probably get nothing at all. Also, the cash flow is less predictable in the common stock. And the dividend payout is uncertain.
Main Differences Between Preferred and Common Stock
- Preferred stock shareholders dont have the right to vote while the common stock shareholders have the right to vote for any decision that has to be made for corporate policies.
- The preferred stock shareholders have the priority to receive dividends than the common stock shareholders.
- The preferred stock is not as much exposed to the risks of the business as the common stock.
- The preferred stock is usually sold at a high rate while common stock is usually sold at the fair market price.
- The cash flow is more predictable in the preferred stock than that of common stock.
- In a board presentation, the preferred stock shareholders are rarely in control while the common stock shareholders are well presented and have control.
Conclusion
Preferred stock has a higher rank than common stock. The cash flow in the preferred stock is more predictable and the dividends payment order is after the debtholders. The dividend is fixed. Also, the preferred stocks are usually sold at a higher price as the preferred stock has some priority over the common stock. Though, in the preferred stock, the stockholders dont have the right to vote in the decisions to make.
A common stock gives the investor an ownership stake in the company. Common stockholders have voting rights. They have the right to vote in any decision the company has to make either it was for corporate policies, mergers, or for the board of directors. The dividend payment order in the common stock is after the debtholders and preferred stockholders.
References
- https://heinonline.org/hol-cgi-bin/get_pdf.cgi?handle=hein.journals/calr42§ion=28
- https://www.cambridge.org/core/journals/journal-of-financial-and-quantitative-analysis/article/an-empirical-analysis-of-common-stock-delistings/10F9709E318D359B713983E4A6CDF41F