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Preferred stock vs. common stock
Key differences between the two shares types can help you become a more educated investor.
Preferred and common stock allow you to own shares — or equity — in a company. But key differences come down to whether you can vote on company direction and what happens in the event of bankruptcy.
What is preferred stock?
Preferred stock is a type of stock that offers stronger shareholder protections than common stock. It’s often referred to as a hybrid security because it combines the qualities of bonds with the same equity ownership of common stocks.
Companies issue preferred stock to raise the necessary capital — or the financing a company can tap into to fund its operations — while keeping debt levels low. Preferred stock shareholders don’t have voting rights over the company’s direction, which helps it to maintain control. It also has the right to call shares of preferred stock after a specific time, which means it buys shares at a redemption rate that’s either the same or greater than the issue price.
Preferred stocks offer advantages for the investor. They provide consistent and guaranteed dividends, though these can be deferred if cash flow is tight, and payments tend to be higher than for a company’s bonds. If the company needs to liquidate or sell property or assets for cash, preferred stockholders are the next in line for a payout behind creditors and bondholders.
What is common stock?
Common stock is the more typical type of security, where each share represents a portion of company ownership. Companies issue common stock to raise capital for everything from expanding the business to paying off debt. Unlike preferred stock, there is no call feature for common stock, so investors can keep it as long as they like.
Investors usually buy common stock for capital appreciation rather than the fixed dividend that comes with preferred stock. As with all investment vehicles, there is risk; the value of the shares rises when the company does well and falls when it doesn’t.
A benefit for common stockholders is that investors typically get one vote per share of common stock, giving them influence over the way the company is managed. Stockholders can vote on board membership, policies and other major corporate decisions. If the company goes under, however, investors who hold common stock are the last to be paid — if there’s anything left.
Preferred vs. common stock
Preferred and common stocks can have a place in an investor’s portfolio. Compare these two stock types on shareholder ownership, dividend earnings and the ability for the company to buy back shares before investing.
|Feature||Preferred stock||Common stock|
|Shares represent ownership in company||Yes||Yes|
|Shares allow voting rights||No||Yes|
|Shares earn dividends||Yes — fixed||Yes — variable|
|Company can buy back shares||Yes||No|
|Order in which shareholder is paid if company defaults||First after creditors and bondholders||Last after creditors, bondholders and preferred stockholders|
7 keywords to know before investing in preferred or common stock
Knowing what each of these common investment terms means can strengthen your confidence over the investment process.
- Equity. Refers to your amount or percentage of company ownership as a shareholder.
- Stock. Represents your portion of the company’s ownership.
- Share. The smallest portion of a company’s stock and an asset that provides an equal distribution of the company’s profits.
- Bond. Debt instruments companies issue to raise capital. When you buy a bond, you’re lending money to the company in exchange for a series of interest payments.
- Dividend. The way in which companies pay shareholders represented as additional shares instead of cash. Fixed dividends remain the same each year as long as the company is profitable.
- Broker. An entity that arranges transactions among you, the buyer, and the company you’re investing in, the seller.
- Capital appreciation. An increase in the stock’s value or price.
How to buy stock
The process for buying shares of preferred stock is the same as it is for common stock.
- Sign up with a broker. Look for low fees and minimums, current registration and licensing, a good reputation among investors and an easy-to-navigate website or app.
- Fund your account. Buy stock in the company of your choice after you’ve funded your account.
- Research your target company. All stocks are rated by ratings agencies like Moody’s, Fitch or Standards and Poor’s that conduct careful analysis for investors. Higher ratings indicate lower risk.
- Decide how many shares to buy. Divide the money you want to spend by the share price. For example, if you have $5,000 and the preferred stock is $2 per share, you can buy 2,500 shares.
- Purchase your shares. Most brokers allow you to buy online with the stock symbol.
- Monitor the stock’s performance. You can keep most shares for as long as you want and sell when it makes sense for you.
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In the end, you may not want to choose between preferred or common stock. Owning a combination of the two can be your best strategy. As with all investing, weigh risks against rewards and plan for the growth of your investment before making any decisions.
Looking to find a broker? Read our guide to investing to narrow down the best broker for your budget, comfort level and investing goals.
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