Common Stocks vs Preferred Stocks Which One Is Better

Differences Between Common Stocks and Preferred Stocks | Blog - 20

Introduction:

Welcome to our guide where we'll delve into the world of stocks and explore the differences between common stocks and preferred stocks. Whether you're a novice investor or a seasoned trader, understanding these two types of stocks is essential for making informed investment decisions. In this blog, we'll break down the key characteristics of common and preferred stocks, provide real-life examples, and discuss their pros and cons in simple, easy-to-understand language.

Common Stocks vs. Preferred Stocks | images - freepic

Understanding Common Stocks and Preferred Stocks:

1. Common Stocks:

   - Common stocks represent ownership in a corporation and give shareholders voting rights at shareholder meetings.

   - Example 1: John purchases 100 shares of Company XYZ's common stock, entitling him to vote on company decisions and receive dividends if the company declares them.

2. Preferred Stocks:

   - Preferred stocks are a type of equity security that typically pays a fixed dividend to shareholders before dividends are distributed to common shareholders.

   - Example 2: Sarah invests in 100 shares of Company ABC's preferred stock, which offers a fixed dividend of $2 per share annually, paid quarterly.

Key Differences Between Common Stocks and Preferred Stocks:

1. Voting Rights:

   - Common stockholders have voting rights and can participate in corporate decisions such as electing the board of directors.

   - Preferred stockholders generally do not have voting rights, which means they cannot influence company decisions.

2. Dividend Payments:

   - Dividends for common stocks are not guaranteed and are paid out of the company's profits at the discretion of the board of directors.

   - Preferred stocks typically offer fixed dividend payments, which are paid out before dividends on common stock. However, companies may suspend preferred dividends in certain circumstances.

3. Priority in Liquidation:

   - In the event of liquidation or bankruptcy, common stockholders receive any remaining assets after creditors, bondholders, and preferred stockholders are paid.

   - Preferred stockholders have a higher claim on assets than common stockholders but are subordinate to bondholders and other creditors.

4. Price Volatility:

   - Common stocks tend to exhibit higher price volatility compared to preferred stocks, making them riskier but also offering higher potential returns.

   - Preferred stocks are generally less volatile and provide investors with a more stable income stream through fixed dividends.

5. Convertible Features:

   - Some preferred stocks may have convertible features that allow shareholders to convert their preferred shares into a specified number of common shares at a predetermined price.

   - Common stocks do not typically have convertible features, as they already represent ownership in the company.

Q&A Section:

1. Can preferred stockholders vote on company matters?

   - No, preferred stockholders generally do not have voting rights and cannot participate in corporate decisions.

2. Are preferred dividends guaranteed?

   - While preferred dividends are typically fixed, companies may suspend or reduce preferred dividends in certain circumstances, such as financial distress.

3. Do common stockholders receive dividends before preferred stockholders?

   - No, preferred stockholders receive dividends before common stockholders. Preferred dividends are paid out before dividends on common stock.

4. Can preferred stocks be converted into common stocks?

   - Some preferred stocks may have convertible features that allow shareholders to convert their preferred shares into a specified number of common shares at a predetermined price.

5. Which type of stock is riskier: common or preferred?

   - Common stocks are generally riskier than preferred stocks due to their higher price volatility and lower priority in liquidation.

6. Do preferred stocks offer voting rights?

   - No, preferred stockholders typically do not have voting rights and cannot influence company decisions.

7. What happens to preferred shareholders in case of bankruptcy?

   - Preferred shareholders have a higher claim on assets than common stockholders but are subordinate to bondholders and other creditors in the event of bankruptcy or liquidation.

8. Are preferred stocks traded on stock exchanges?

   - Yes, preferred stocks are traded on stock exchanges like common stocks and can be bought and sold by investors.

9. Do preferred stocks have maturity dates?

   - Preferred stocks may have maturity dates, after which the issuer may redeem the shares at face value. However, many preferred stocks are perpetual and have no maturity date.

10. How are dividends taxed for preferred stockholders?

    - Dividends received by preferred stockholders are typically taxed at the same rate as ordinary income. However, tax treatment may vary depending on individual circumstances and jurisdiction.

Conclusion:

In conclusion, common stocks and preferred stocks are two distinct types of equity securities that offer different rights and benefits to investors. While common stocks provide voting rights and the potential for capital appreciation, preferred stocks offer fixed dividends and higher priority in liquidation. By understanding the differences between these two types of stocks, investors can make informed decisions that align with their investment objectives and risk tolerance.

Blog Credits: Finaxia