In the global equity market, over 90% of shares are issued as either common or preferred stocks. These two types of equity represent the foundation of ownership in public companies. While both grant a stake in a company, they function differently in practice. Investors must know how they vary to make informed decisions.
What Are Common Stocks?
Common stocks are the most widely issued form of equity. They represent ownership in a company and entitle shareholders to a portion of the profits. This entitlement comes through dividends and capital appreciation. Owners of common stock usually have voting rights.
Shareholders vote on corporate matters, such as electing the board of directors. This gives them a voice in company policies. The price of common stock changes based on market demand. Company performance, news, and broader market conditions affect this price.
Common stocks carry more risk but offer higher potential returns. If the company grows, the stock price rise. However, in times of crisis or bankruptcy, common shareholders are last in line for payment. Creditors, bondholders, and preferred shareholders come first.
What Are Preferred Stocks?
Preferred stocks are a hybrid between stocks and bonds. They represent ownership in a company, but they function more like fixed-income assets. Preferred shareholders receive fixed dividends regularly. These payments are made before any dividends go to common shareholders.
In bankruptcy, preferred shareholders rank above common ones. They have a greater claim on assets. Most preferred stocks do not come with voting rights. This makes them more passive investments focused on income.
Preferred stock prices are more stable. They don’t rise and fall as sharply as common stocks. Because they pay fixed dividends, their value behaves more like a bond. Companies may issue preferred stock to raise capital without diluting voting power.
Difference between Common Stocks and Preferred Stocks
There are some differences between common stocks and preferred stocks. Some common differences are-
Ownership Rights: Voting vs Priority
The most obvious difference lies in ownership rights. Common shareholders vote. They influence corporate decisions. This gives them some control over company direction. Each share typically equals one vote.
Preferred shareholders rarely have voting rights. They do not participate in corporate governance. Their focus is fixed income and capital preservation. This makes preferred stock appealing to income-seeking investors.
In a liquidation, preferred shareholders receive payment before common shareholders. This gives them a higher claim on company assets. However, neither group outranks debt holders.
Dividend Structure: Variable vs Fixed
Common stock dividends are not guaranteed. They depend on company profits and board approval. Some companies don’t pay dividends at all. Others reduce them during financial downturns.
Preferred stocks pay fixed dividends. The amount is set when the shares are issued. These dividends are usually paid quarterly. If the company cannot pay, the dividends may be deferred. In many cases, missed payments must be paid before common stock dividends resume.
Some preferred stocks are cumulative. This means unpaid dividends accumulate and must be paid in full. This protection does not exist for common shareholders.
Volatility and Risk: Growth vs Stability
Common stocks are more volatile. Their prices respond to earnings, market trends, and economic shifts. This volatility brings higher growth potential but also higher risk.
Preferred stocks are less volatile. Their fixed income makes them behave more like bonds. Investors view them as safer than common stocks but riskier than debt. They are not immune to market forces, but they fluctuate less in price.
In bull markets, common stocks tend to outperform. Their price surge with company growth. In bear markets, preferred stocks hold value better due to their steady income stream.
Capital Gains vs Income
Investors buy common stocks for capital gains. They expect the stock price to rise over time. If they sell at a higher price, they earn a profit. This strategy is based on growth and market performance.
Preferred stocks focus on steady income. Investors rely on the fixed dividends. While preferred shares may gain in value, the gains are smaller and less predictable. The return comes mostly from dividend payments.
Because of this, preferred stocks appeal to conservative investors. Common stocks attract those seeking higher long-term gains.
Convertibility and Callability
Some preferred stocks are convertible. They can be exchanged for a set number of common shares. This feature allows investors to benefit from stock price increases. If common shares rise sharply, converting preferred shares becomes profitable.
Preferred stocks may also be callable. This means the company can buy them back after a certain date. If interest rates fall, the company may redeem preferred shares and issue new ones at lower rates. This limits potential long-term returns for investors.
Common stocks are neither callable nor convertible by the company. Investors control when to sell or hold.
Issuance and Market Behavior
Most companies issue common stock when going public. This is their primary method of raising equity capital. Common stock issuance is common during IPOs and secondary offerings. Investors usually have full market access to these shares.
Preferred stock is issued less frequently. It is often targeted at institutional investors or specific capital structures. Companies use it to raise funds without affecting control or share dilution.
On the open market, common stocks have higher liquidity. They are traded more frequently and have tighter spreads. Preferred stocks trade less, with wider spreads and lower volume.
Tax Treatment of Dividends
In many countries, common stock dividends receive favorable tax treatment. For example, in the U.S., they may qualify as “qualified dividends” and be taxed at lower rates.
Preferred dividends can qualify as well, depending on the structure and holding period. However, some preferred shares issued by financial institutions or foreign entities may not get the same benefit. Tax treatment affects net returns and must be considered.
Suitability for Different Investors
Common stocks suit growth-oriented investors. These investors can tolerate risk and aim for long-term wealth. They accept short-term losses for future gains. Active traders and long-term equity holders fit this profile.
Preferred stocks suit income-focused investors. These investors want regular payments and lower volatility. Retirees and conservative portfolios include more preferred stocks. They value capital protection and stable income.
Market Performance and Historical Trends
Historically, common stocks have outperformed preferred stocks in total returns. This is due to capital gains. For example, from 1990 to 2020, the S&P 500 delivered over 9% average annual returns. This included both price appreciation and dividends.
Preferred stocks delivered lower returns, around 5%–7% annually. However, they offered less risk. During the 2008 financial crisis, preferred shares held up better than common stocks in some sectors, such as utilities and banking.
Despite lower returns, preferred stocks performed better during economic downturns. Their fixed dividends created a buffer against market losses.
Regulatory and Reporting Differences
Companies must meet reporting standards for both stock types. However, preferred shares may be listed separately with different terms. This can include dividend rates, maturity dates, and redemption features.
Prospectuses and regulatory filings disclose these terms. Investors must read them carefully. These documents outline investor rights and obligations. Common shareholders have simpler terms but greater exposure to market risk.
Sector Use of Preferred Stock
Certain sectors issue more preferred stock. Utilities, banks, and insurance companies are the largest issuers. These sectors need steady capital and want to avoid diluting control.
In banking, regulators allow preferred stock to count toward capital reserves. This helps banks meet solvency ratios without issuing debt. Utility companies use preferred stock to fund long-term infrastructure projects.
Common stock is universal. Every sector issues it. It serves as the primary form of equity capital for most public companies.
Access and Pricing Transparency
Common stocks have full pricing transparency. They trade on major exchanges like the NYSE and NASDAQ. Prices are updated in real-time. Investors can see bid-ask spreads and market depth.
Preferred stocks may be harder to track. Some trade on smaller exchanges or over-the-counter. Prices update less frequently. Fewer analysts follow them, and news coverage is limited. This affects visibility and pricing accuracy.
Impact of Interest Rates
Interest rate changes affect preferred stocks more. Rising rates reduce the appeal of fixed dividends. Investors may shift to newer issues with higher yields. This causes existing preferred stock prices to fall.
Common stocks react differently. They may fall due to higher borrowing costs. But if rates rise due to economic growth, earnings may grow too. This can offset the negative effect. Interest rate sensitivity is stronger in preferred stocks.
Investor Protections and Limitations
Preferred shareholders have stronger dividend protections. Many issues are cumulative. Missed payments must be honored later. This makes income more reliable.
Common shareholders have no such guarantee. If the company struggles, dividends may be cut or stopped.
However, common stockholders benefit fully from company growth. If profits soar, they get higher dividends and share prices. Preferred investors do not share in this upside to the same degree.
বুThe choice between common and preferred stocks depends on investor goals. Those seeking long-term growth may choose common stock. Those who prioritize income and stability may prefer preferred stock.
Understanding their differences can help investors build better portfolios. A balanced mix of both may offer the right blend of income and growth. Smart investors match their strategy with the stock that fits best.
