Many of you who have background in Finance and Accounting or have been investing for quite sometime already, understand and know what common stock is. But definitely a lot are still unfamiliar with the term preferred stock.
For today, we will answer another common question that we regularly receive from new investors: What are common and preferred shares and what’s the difference?
What’s the Difference between Common and Preferred Stocks?
Common stocks are the most popular and basic type of equity that we trade in the stock market. It basically pertains to an ownership in a company.
Investors in common stocks earn in two ways: (1) through share price appreciation and (2) through increasing dividends.
However, there are big companies that don’t pay dividends (yet). Investors who have common shares can elect the board of directors and vote on various current issues that the company is going through.
One major risk of having a common stock is that its prices fall and that you may lose everything that you invested in.
Another drawback on being a common shareholder is that you are the last to receive claims on earnings and assets of a company should it go bankrupt.
You will only be paid after all the preferred shareholders and creditors are paid first.
Preferred stocks are also sold by companies and is then traded among investors in the secondary market.
Buying preferred shares is also less risky than common stock that’s why returns from it are not as substantial as compared with earnings from common shares.
There are few advantages in holding preferred shares though such as:
1) Preferred stockholders are the first to receive dividends and overdue debts before common shareholders receive theirs.
2) Fixed dividends that yield more than common dividends are issued to preferred shareholders.
3) If a company becomes bankrupt and liquidation of assets are about to occur, preferred shareholders receive any cash left before common shareholders receive any money.
One disadvantage of preferred shares is that even if the company earns more profits, preferred shareholders received the same fixed dividends.
Another major disadvantage is that preferred shareholders have no voting rights.
Here’s The Skinny On books series author Jim Randel explaining the difference between preferred stocks and common stocks in simple layman’s language.
I hope you enjoy watching his very short video about this topic.
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