Published - November 30, 2022 @ 1:00 PM (EET)
While individuals looking to invest in publicly traded companies can easily do so by purchasing shares, it is worth noting that there's more than just one type of stock, and not all are created equal.
Buying shares grants investors a fractional ownership stake in a company and, in turn, is a source of funding that helps companies grow.
Most investors buy and sell common stock, but there is also preferred stock, perhaps a little less familiar.
Individuals can find both types of stock on major exchanges, and though both can be worthwhile investments, here is a look at the differences and the pros and cons of both instruments.
COMMON STOCK
The main difference between common stock and preferred stock is that different classes of common stock in a public company allocate varying voting rights based on the stock class the common stockholders own, usually at one vote per share.
Common stock has higher long-term growth potential but also has lower priority for dividends and a payout in the event of a liquidation. It means that, when it comes to company assets, common stockholders will be the last to be paid out after creditors, bondholders, and preferred shareholders.
Probably one of the most attractive features of common stock is that its value can rise dramatically over time as a company grows bigger and more profitable, thus creating more returns for investors. The flip side is that the price can also go down, resulting in loss to shareholders if the company does not perform well, making it more volatile and risky.
PREFERRED STOCK
Preferred stock offers more regular, scheduled dividend payments and usually does not provide the same voting rights or as much growth potential in value over time. Under some agreements, however, voting rights may revert to preferred shareholders that have not received their dividends.
Dividends on preferred stock are determined in advance and have a set redemption price that a company will eventually pay to redeem it, similar to a bond when the instrument reaches maturity.
Like bonds, preferred shares' par value is affected by interest in which the value of the preferred stock declines when interest rates rise and vice versa. Lastly, common stock cannot be converted into another security, whereas preferred stock can easily be transferred to common stock or debt.
The 3 Key Differences
1. Growth potential - Common stocks can experience significant market fluctuations, with nearly unlimited potential for higher gains and losses. On the other hand, preferred stocks usually come with a fixed-amount redemption value, which means that shareholders cannot sell their preferred stock at a considerable amount if the price increases.
2. Stability - Preferred stock often acts more like a bond whereby dividend yields are much higher and are fixed at a specific rate, making it a more stable investment than common stock. Short-term investors who cannot hold common stocks long enough to overcome dips in the share price may want to consider preferred stock since they experience much less dramatic swings.
3. Voting rights - Investors holding common stock typically have the right to vote on the company's board of directors and approve major corporate decisions, such as mergers. Many companies have multiple classes of common stock, with each class having more voting power than others.
CONCLUSION
Usually, institutional startup investors find preferred stock more attractive as it provides higher profitability at lesser risks, giving them long-term wealth growth and control over their startups.
Retail investors often find investing in listed common stock the better choice for long-term growth because of the more significant upside potential. Therefore, consider your overall portfolio goals, whether long-term or short term if you choose to invest in preferred shares.
Although preferred shares come with high dividend payments, it has limited growth potential, and while they offer more dividend security than common stocks, dividends are still not guaranteed.
