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Those looking to invest in publicly traded companies can easily do so by purchasing shares of stock on the open market. Broadly speaking, stock gives the investor a fractional ownership stake in the company. Meanwhile, companies use the money from stock sales to invest in growth, pay off debt, or ramp up their research and development, among other potential uses.
However, there’s more than just one type of stock. While most investors buy and sell what is known as common stock, companies may also issue something called preferred stock. And each of these types can be further divided into classes.
Here are the key differences between common and preferred stock.
Common stock vs. preferred stock: How they compare
Not all stock is created equal. Common stock and preferred stock are the two types of stock that are most often issued by publicly traded companies and they each come with their own set of pros and cons.
Common stock
Common stock isn’t just common in name only; this type of stock is the one investors buy most often. It grants shareholders ownership rights, allows them to vote on important decisions such as electing the board of directors and gives them a say in certain policy decisions and management issues. Each share usually has one vote. Compared to preferred stock, common stock’s profit potential tends to come more from growth in share price over time rather than dividends.
Common stock has higher long-term growth potential than preferred stock but also has lower priority for dividends and a payout in the event of a liquidation. Lenders, suppliers and preferred shareholders are all in line for a payout ahead of common stockholders. Common stock also has a greater chance of falling substantially in price than preferred stock.
Common stock tends to be better suited to long-term investors.
Pros
- Grants voting rights
- No limit on how much the share price can grow
- Taxes on capital gains are deferred until stock is sold
Cons
- Greater price volatility than preferred stock
- May not receive dividends
- Dividends are paid out to preferred shares first, then to common shares
- Lower priority than preferred shares to receive a payout in a liquidation
Preferred stock
Preferred stock is a type of stock that pays shareholders a specified dividend and has priority over common stock for receiving dividends. Despite its name, preferred stock isn’t necessarily preferred by most investors (though it does have its benefits).
In many ways, preferred stock is like a bond. For example, the major source of return on a preferred stock is usually its dividend. Preferred stock is also more likely to pay out a higher yield than common shares. Like bonds, preferred stock performs better when interest rates decline. And preferred stock has a par value, that is, a value it’s issued at and can typically be redeemed at, when the preferred shares mature.
Preferred stock also can be “called” (i.e., redeemed by the company) on a prespecified date. Thus, there is a possibility the call price could be higher than the price the investor paid. Another unique feature of some types of preferred stock is they can be converted into a fixed number of common shares. This type of stock is called convertible preferred stock.
Preferred stock may be a better investment for short-term investors who don’t have the stomach to hold common stock long enough to overcome dips in the share price. Preferred stock tends to fluctuate a lot less than common stock, though it also has less potential for long-term growth.
Pros
- Receives a specified dividend that is often higher than common stock dividends
- Less chance of losing value
- Has priority over common stock for payout in a liquidation, as well as for receiving dividends
Cons
- Growth in share price is generally limited, up to the redemption value
- Often does not grant voting rights
- Price may fall if interest rates rise significantly
How stock classes work
In most cases, when a company issues common stock, it issues only one class of common stock. However, in some cases, companies may issue multiple share classes, often called Class A, Class B, and Class C shares, for example.
Traditionally, Class A shares are publicly traded and come with one vote, just like other types of common stock. Class B shares, on the other hand, may only be available to company owners and executives. In addition, they may have greater voting power than a single vote per share. Lastly, Class C shares tend to be much like Class A shares, but may often have no voting rights.
Preferred stock can have different classes, too. In the case of preferred stock, different classes have different priorities in terms of dividends and a payout in a liquidation. But these classes still have priority over common shares. Like bonds, each series of preferred stock has its own dividend, call date and other terms.
How do you buy and sell preferred or common stocks?
Investors looking to purchase preferred or common stock will likely do so through a broker. Most online brokers have cut trading commissions to zero, so you won’t have to worry about high costs to place an order. If you go through a traditional broker, trading fees will likely be higher.
Once you’ve identified the security you’re interested in buying, you can place a trade for the number of shares you’d like to purchase. Not all companies offer preferred stock, so be sure to check what’s available through your broker.
Here are some of the best online stock brokers to buy and sell stock.
Is preferred stock safer than common stock?
Broadly speaking, preferred stock is less risky than common stock because payments of interest or dividends on preferred stock are required to be paid before any payments to common shareholders. This means that preferred stock is senior to common stock. But a company’s bonds are senior to preferred stock, so while preferred stock comes with less risk than common, it does carry more risk than a bond.
Bottom line
If you look at a list of pros and cons for each type of stock, it might seem like preferred stock is better. However, while preferred stock has a higher priority for dividends and to receive a payout, that doesn’t necessarily mean preferred stock is better. In general, common stock has greater long-term growth potential, meaning common stocks may be better suited for long-term investors. So, which type is better for you depends on your situation.
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