‘Stock’, a term used to denote securities that carry ownership interest and reflect potential claim on the assets and income, earned by the corporation. It also indicates, the net worth or shareholder’s equity, of the firm, which can be arrived by deducting total liabilities from total assets. The investors who contribute money through stocks are known as stockholders.
Stocks are classified into two broad categories, i.e. common stock and preferred stock. The former implies the ordinary stock issued by the companies, while the latter, are the ones that carry preferential rights regarding dividend payment and repayment of capital.
If you are a novice to the stock market and have no idea about the classes of stock, then this article might prove helpful to start your investment journey. So, to make a rational decision regarding investment in any of the two, all you need to know is the difference between common and preferred stock.
Content: Common Stock Vs Preferred Stock
|Basis for Comparison||Common Stock||Preferred Stock|
|Meaning||Common stock refers to the ordinary stock, representing part ownership and confers voting rights to the person holding it.||Preferred stock, represents that part of company's capital that carry preferential right, to be paid, when the company goes bankrupt or wound up.|
|Rights||Differential Rights||Preferential Rights|
|Return on capital||Not guaranteed.||Guaranteed and that too, at a fixed rate.|
|Partipation in elections||Entitles a person to participate and vote in the company's meeting.||Does not entitles a person to participate and vote in the company's meeting.|
|Repayment priority||Payment to common stockholders are made at the end.||Preferred stockholders are paid before common stockholders.|
|Redemption||Cannot be redeemed||Can be redeemed|
|Arrears of dividend||They are not entitled to arrears of dividend, if skipped in the previous year.||They are entitled to arrears of dividend, if skipped in the previous year.|
Definition of Common Stock
Common Stock represents the owner’s fund, as equity shareholders jointly own the company. The stockholders are entitled to both risk and rewards of ownership, but their liability is limited to the capital contributed by them.
In general, a publicly traded company issues common stock to raise funds, at a price, the market is willing to pay. The investment value of such stocks goes up irregularly but persistently, over the years, because of the reinvestment of undistributed earnings, builds up the net worth. Although, they face a considerable amount of fluctuations in price, due to speculation. The rights of common stockholders are discussed below:
- Right to Income: Common stockholders have a residual claim on the earnings of the firm.
- Right to Vote: Common stockholders, has the right to elect firm’s board of directors and vote on various corporate policies, at the general meeting.
- Pre-emptive Right: The pre-emptive rights allows the existing stockholders to buy the company’s stock before they are publicly available, so as to maintain their proportional ownership.
- Right in Liquidation: Common Stockholders are entitled to receive the leftover amount and assets of the firm in the event of liquidation, i.e. once all the creditors, debenture holders, preferred stock holders are paid off, the amount and assets remained are distributed to common stockholders in the ratio of their ownership in the company.
Definition of Preferred Stock
Preferred Stock implies a class of security, which do not carry voting rights but have a higher claim on the company’s assets and income. Preference stockholders enjoy preference in certain matters, as to the payment of fixed amount of dividend and repayment of capital in the event of liquidation or bankruptcy. It is a fixed income bearing investment vehicle, which may or may not have a maturity period.
Preferred Stock is the hybrid form of security, that imbibes features of common stock and debt, in the sense that they carry a fixed rate of dividend, which should be paid only out of distributable profit. Further, the nature of dividend is cumulative, in essence, that if the payment of dividend is skipped in a particular year, then the dividend is carried forward to next year and arrears of dividend has to be paid by the company. If the payment of dividend is not made consistently for three years, then stockholders become eligible to vote at the general meeting.
Key Differences Between Common and Preferred Stock
The difference between common and preferred stock are discussed in detail, in the points given below:
- Common Stock, implies the type of stock ordinarily issued by the company to raise capital, indicating part ownership and carry voting rights. Preferred Stock is that class of stock, which gets priority regarding the payment of dividend and repayment of capital.
- Common Stock have high growth potential, as compared to preferred stock, whose propensity to grow is slightly low.
- Common Stockholders return on capital is neither guaranteed, nor the amount is fixed. Unlike preferred stockholders, whose return is guaranteed and that also at a fixed rate.
- Common Stock carries differential rights regarding voting, dividend and repayment of capital. On the other hand, the preferred stock holds preferential rights as to the dividend and capital repayment.
- Common stock entitles a person to participate and vote in the company’s general meeting. As against this, preferred stock does not allow a person to participate and vote in the company’s general meeting.
- Common Stock can never be redeemed by the company. Conversely, preferred stock is redeemed by the company, either on their maturity or when the company wants to buy back.
- Common Stock cannot be converted into any other security, whereas preferred stock can easily be converted into common stock or debt.
- Common stockholders are not entitled to an arrear of dividend, if not paid by the company in the previous year, due to insufficient funds. On the flip side, preferred stockholders are entitled to arrears of dividend, if it is skipped in the previous year, or else they acquire voting rights if the company skips dividend payment for three consecutive years.
So, you might have decided till now, which investment vehicle to opt, but before coming down to any conclusion, first consider the following factors, i.e. long term and short term goals, risk tolerance, growth potential and liquidity needs. Concerning growth, common stock has the edge over preferred stock, but when it comes to risk, preferred stock is less riskier than common ones.