Common stock vs preferred stock

Introduction

When people talk about investing in stocks, they are usually referring to common stock. However, common stock is not the only type of stock that companies can issue. Many companies also offer preferred stock, which comes with a different set of rights and benefits for investors.

Although both common and preferred stock represent ownership in a company, they differ in several important ways. These differences can affect how investors earn returns, how much risk they take on, and what happens if a company runs into financial trouble. Factors such as voting rights, dividend payments, growth potential, and bankruptcy priority all play a role in distinguishing the two.

Understanding these differences can help you make more informed investment decisions and choose the type of stock that best aligns with your financial goals. In this guide, we’ll compare common stock and preferred stock, explain their key characteristics, and discuss the advantages and disadvantages of each.

Common stock and preferred stock

Although both represent ownership in a company, common stock and preferred stock are designed for different purposes. Understanding how they work is the first step toward choosing the type that best fits your investment goals.

Key differences

Feature	Common Stock	Preferred Stock
Ownership	Represents ownership in a company	Represents ownership in a company
Voting Rights	Usually includes voting rights	Usually does not include voting rights
Dividend Payments	Dividends are variable and not guaranteed	Dividends are usually fixed and paid before common dividends
Growth Potential	Higher potential for long-term price appreciation	More limited growth potential
Income Stability	Less predictable income	More predictable income
Risk Level	Generally higher risk	Generally lower risk than common stock
Bankruptcy Priority	Lowest priority among investors	Higher priority than common shareholders
Best Suited For	Investors seeking long-term growth	Investors seeking income and stability

Dividend payment priority

One of the biggest differences between common stock and preferred stock is the order in which dividends are paid. As the name suggests, preferred shareholders have priority over common shareholders when a company distributes dividends.

If a company declares a dividend, preferred shareholders are paid first. Only after all preferred dividend obligations have been met can any remaining dividends be distributed to common shareholders. This gives preferred investors a more predictable source of income, particularly for companies that regularly pay dividends.

However, it’s important to understand that preferred dividends are not always guaranteed. If a company experiences financial difficulties, it may decide to reduce or suspend dividend payments altogether. In that case, the treatment of preferred shareholders depends on whether the preferred stock is cumulative or non-cumulative.

• Cumulative preferred stock allows unpaid dividends to accumulate. The company must pay these missed dividends before any dividends can be paid to common shareholders.
• Non-cumulative preferred stock does not provide this protection. If a dividend is skipped, shareholders generally lose the right to receive that missed payment.

Because common shareholders are paid last, they are more likely to experience dividend cuts or suspensions during periods of financial stress. On the other hand, when a company performs well, common shareholders may benefit from larger dividend increases over time, while preferred dividends typically remain fixed.

Bankruptcy priority

Another important difference between common and preferred stock is what happens if a company goes bankrupt. When a business is liquidated, its remaining assets are distributed according to a legal order of priority.

Creditors and bondholders are paid first because they have a contractual claim on the company’s assets. Preferred shareholders are next in line, giving them a higher claim than common shareholders. Only after all outstanding obligations have been satisfied can any remaining assets be distributed to common shareholders.

In reality, there is often little or nothing left for shareholders once creditors have been paid. While preferred shareholders have a better chance of recovering some of their investment, both types of stock carry the risk of losing value if a company fails.

Growth Potential

Although preferred stock offers greater income stability, common stock generally provides much stronger long-term growth potential. The share price of common stock reflects the company’s future earnings and business performance, allowing investors to benefit from capital appreciation as the company grows.

Preferred stock behaves differently. Because its dividend payments are usually fixed, its price tends to fluctuate less and offers more limited upside. For this reason, preferred stock is often viewed as an income investment rather than a growth investment.

Investors seeking to build wealth over many years typically favor common stock, while those who prioritize reliable income may prefer preferred stock.

Advantages and disadvantages

Both common and preferred stock have their own strengths and weaknesses. The better choice depends on your investment goals, risk tolerance, and income needs.

Which stock is right for you?

Neither common stock nor preferred stock is inherently better. The right choice depends on what you want to achieve as an investor.

Common stock is generally more suitable for investors who are focused on long-term growth and are willing to accept greater price fluctuations in exchange for potentially higher returns. This is why common stock is the most popular choice among long-term investors.

Preferred stock, on the other hand, may be a better fit for investors who value steady income and lower volatility. Because preferred shareholders receive dividends before common shareholders, these investments can provide a more predictable cash flow, although they usually offer less opportunity for capital appreciation.

Many investors build their portfolios primarily with common stocks, while preferred stocks are often used by income-focused investors who prioritize stability over growth.