Investors navigating the complex landscape of the stock market often encounter the terms preferred stocks and common stocks. While both represent ownership in a company, they come with distinct characteristics and rights that can significantly impact an investor’s experience. Understanding the key differences between preferred stocks and common stocks is crucial for making informed investment decisions. In this blog, we will explore the two further.
Table of Contents
Defining Common Stocks
Common stock, also known as equities or shares, represents ownership in a company listed on a stock exchange in India, such as the Bombay Stock Exchange (BSE) or the National Stock Exchange (NSE).
- Investors can buy and sell common stock through a broker, and the value of the stock can fluctuate based on a variety of factors, including the company’s financial performance and overall market conditions.
- Common shareholders are entitled to vote on corporate matters, such as the election of the board of directors, and have the potential to earn dividends and capital appreciation.
Defining Preferred Shares
Preferred stocks, also known as preference shares, are a type of equity security representing ownership in a company listed on a stock exchange in India, such as the Bombay Stock Exchange (BSE) or the National Stock Exchange (NSE).
- Preferred stocks typically have a higher claim on assets and earnings than common stocks, and dividends on preferred stocks are generally paid at a fixed rate.
- Preferred stockholders do not typically have voting rights. In case of liquidation of the company, preferred shareholders will be paid before common shareholders.
- In India, preferred stocks are generally offered by companies looking for long term capital. They are issued at a premium and pay a fixed rate of dividend, which is generally higher than the rate of interest paid on fixed deposits.
- Preferred stocks are considered less risky than common stocks but riskier than bonds.
Differentiating Preferred Stock and Common Stock
The common share represents ownership in a company and entitles the holder to vote on corporate matters and receive dividends. Preferred stock typically does not have voting rights but has a higher claim on assets and earnings than common stock. Additionally, preferred stock dividends are often paid at a fixed rate and have priority over dividends for common stockholders. In the event of a company’s liquidation, preferred stockholders will be paid before common stockholders. Let us find out more.
Aim
Common stocks are always mentioned when discussing equities among investors. Over time, common stock returns often beat those of other stock kinds. It is a result of the business succeeding by raising its long term profitability. The real objective for purchasing common shares is voting power, which investors believe to be essential to a company’s ability to succeed financially. Investors in common stocks worry that a corporation may make poor choices to safeguard their interests rather than consider the profitability of the business. As a result, they purchase common stocks so that they can vote and participate in internal decision-making as well as elect the board of directors. There is less trading in preferred equities because of their scarcity. Due to the priority claim factor, which has two ways in which it impacts investors, investors favour preferred equities over common stocks.
Prior to any other stockholders, preferred investors get dividend payments from the corporation if a dividend is declared. The preferred stockholders get priority over other stakeholder classes when it comes to claiming corporate assets in the event of bankruptcy. The main motive for purchasing preferred shares is to generate a consistent income by claiming priority for dividend payments. Additionally, holders of preferred stock have the right to make a cumulative claim for any misses that are distributed before common stockholders.
Ownership of a Business
The corporation is owned by the holders of both common stock and preferred shares.
Electoral Rights
Even though both preferred and common shareholders own a portion of the business; only the former have voting rights. Shareholders with preferred status are not able to vote. A vote on the new board of directors, for instance, would allow common shareholders to have a say but exclude preferred owners from participating.
Income Claim
There is a schedule for paying investors after a company declares earnings. Shareholders often receive payment first, followed by common shareholders. Preferred shareholders receive their dividends after bondholders but before common stockholders, since preferred shares are a hybrid of both bonds and common shares. Preferred shareholders are entitled to receive payment first to common investors in the case of a company’s bankruptcy
Conversion
Common shares cannot be converted into preferred shares, while preferred shares can be converted into a predetermined number of common shares.
Returns
A company’s earnings are used to pay out both regular and preferred shares. Commonly, the returns on a common share are determined by the rise or fall in share price, including any optional dividends paid. The returns on a preferred share, however, are primarily determined by its required dividends.
Conclusion
Preferred stocks and common stocks are two distinct classes of equities, each with its own set of features and benefits. Common stocks offer ownership in a company along with voting rights at shareholder meetings, providing investors with a say in corporate decisions. On the other hand, preferred stocks come with priority in dividend payments and asset distribution in the event of liquidation, making them appealing to income-focused investors. While common stocks are more prevalent and offer potential for higher returns, preferred stocks provide a steady income stream and greater security. Investors should carefully weigh their investment goals, risk tolerance, and income needs when choosing between these two types of stocks, ensuring their portfolio aligns with their financial objectives.
