Difference Between Common Stock and Preferred Stock

Introduction to Common Stock

A ticket to ownership in a firm, common stock is more than simply a piece of paper (or, these days, a digital entry). By casting a vote for the board of directors and corporate policy, owners of common stock have a say in how the company is run. This kind of equity might provide alluring rewards in the long run. However, keep in mind that there is a catch: in the event that a corporation must liquidate its assets, bondholders, preferred shareholders, and other creditors will receive paid first, followed by common stockholders. The portion of a company's balance sheet dedicated to shareholder equity reports the value of issued common shares.

Common stock essentially functions as a claim to a portion of the assets and profits of a corporation, serving as a kind of ownership. Being a shareholder entitles you to "part-ownership," but this does not provide you ownership of the company's tangible assets, such as computers or chairs, which are owned by the corporation, a separate legal entity. Rather, you have a residual claim to the company's assets and earnings as a shareholder, which means you may keep what's left over after all other responsibilities are fulfilled.

Common stock is traded on exchanges and is available for purchase and sale by traders or investors. Common shareholders are entitled to dividends upon declaration by the board of directors of the corporation.

Usually, they are distributed by the board of directors, who consider many aspects, like the company's performance, potential capital needs, and overall financial objectives, when deciding how much to give each member. The Dutch East India Company issued the first common stock in 1602, and it was listed on the Amsterdam Stock Exchange. Over the next four centuries, there have been several stock exchanges established across the world, listing tens of thousands of firms on prominent platforms such as the Tokyo Stock Exchange and the London Stock Exchange.

Public exchanges like the New York Stock Exchange (NYSE) and Nasdaq are where larger U.S. stocks are traded. By market capitalization, the NYSE was the biggest stock exchange in the world as of the start of 2024, with over 2350 listings of its own and an additional 5700 listings from other U.S. stock exchanges. Smaller businesses whose stocks are traded over the counter are deemed unlisted and are not allowed to list on these main exchanges.

Pros and Cons of Common Stock

Pros

• More often traded than preferred stock
• Greater potential rewards
• Voting privileges

Cons

• No dividends could be received.
• In the case of insolvency or as a lower priority for dividend payments
• Increased price fluctuations

A Guide for How to Invest in Common Stock

Any investor's portfolio should include stocks as a significant component. Compared to bonds, CDs, and preferred stocks, they are riskier. But there's also a bigger chance of payoff with the larger risk. Stocks have higher short-term volatility than other assets, but they often perform better over the long run.

A variety of common stock types are available to investors. Growth stocks are associated with firms that are anticipated to have growth in earnings, which adds value to their shares. In contrast to growth companies, value equities are often more affordable in relation to their fundamentals and offer dividend payments.

By market capitalization, stocks are further divided into large-, mid-, and small-cap groups. Large-cap stocks are often solid, well-established businesses that are traded more frequently.

On the other hand, small-cap stocks are typically more volatile and typically belong to younger, growth-oriented companies.

Features of Common Stocks

Investors must comprehend the characteristics of ordinary stocks-

1. Ownership: Common shareholders own a portion of the company's assets and income, as well as the opportunity to vote on corporate decisions.
2. Dividends: Although they are possible, dividends to common stockholders are not certain. The choice to disperse earnings and the profitability of the firm are the determining factors for dividend distribution.
3. Voting Rights: Shareholders may be able to cast ballots on corporate issues including the selection of directors and significant business choices, depending on the class of common stock they own.
4. Residual Claims: Though they are ranked behind bondholders and preferred shareholders in the hierarchy, common stockholders have a residual claim on the company's assets in the case of bankruptcy or liquidation.

Types of Common Stock

1. Growth Stocks:

Features: Growth stocks are associated with firms that are rapidly expanding and frequently reinvest their earnings to support further growth. Bajaj Auto and Bank of Baroda are two examples.

Focus of investments: Since they believe that a stock's value would rise over time, investors aim for capital appreciation.

2. Equities with Value:

Features: Lower P/E ratios and undervaluation by the market are characteristics of value stocks. L & T Technologies and Abbott India are two examples.

Focus on investments: Traders search for equities that are undervalued in the market, expecting a bounce back when sentiment shifts.

3. Third, Large-cap Stocks

Features: Market capitalization of more than Rs. 20,000 crore indicates that large-cap equities are held by reputable businesses. Tata Consultancy Services (TCS) and Cipla Limited are two examples.

Focus on investments: These companies appeal to investors who value stability, dividends, and minimal risk.

4. Equities with a Mid-cap:

Features: Mid-cap companies are characterized by a market capitalization ranging from Rs. 5,000 crore to Rs. 20,000 crore. Castrol India and Just Dial are two examples.

5. Small-cap Stocks:

Features: Typically exhibiting strong growth potential, small-cap stocks have a market capitalization of less than Rs. 5,000 crore. Bajaj Steel Industries and Remus Pharma are two examples.

Focus on investments: Investors want significant growth, putting up more risk in exchange for possible rewards.

Introduction to Preferred Stock

A separate form of stock known as preferred stock has rights that are different from those of ordinary stock. Although ownership in a corporation is conferred by both categories, preferred shareholders are entitled to a greater share of the firm's assets and dividends than common stockholders.

The designation of "preferred" shares reflects this higher standing.

Pros and Cons of Preferred Stock

Pros

• Increased dividend priority
• Decreased volatility in prices
• Steady payouts that don't change

Cons

• You might not be able to vote.
• Reduced possibilities for profit
• Less frequency in Trading

A Guide for How to Make Investments in Preferred Stock

Preferred stock can be traded by investors in the same way as regular stock. When investing in them, however, investors require a distinct strategy due to their differences from ordinary stock.

It is crucial to do research about the issuing firm. Purchasing a company's preferred shares carries the same level of risk as purchasing its common stock. Both kinds of shares are likely to result in losses if the business performs poorly.

The dividend is an important factor to take into account while selecting preferred stock. Check if the yield provides a compelling return by comparing the dividends you will get to the share price. Higher gains may come from a higher yield.

Additionally, find out if the stock is convertible or callable. Future dividend payments may be withheld from you if the issuer decides to repurchase callable preferred stocks at a certain date and price. Conversely, convertible preferred stock has the ability to be changed into common stock at the company's option, which may be advantageous should the price of the common stock rise sharply.

Features of Preferred Stock

A unique set of characteristics sets preferred shares apart from debt or ordinary stock. The following characteristics are typical, even if the words may differ:

• Asset Preference: In the event of a liquidation, holders of the shares will have the upper hand over holders of ordinary stock in claiming the company's assets.
• Dividend Payments: Stockholders get dividend payments from the shares. Depending on an interest rate benchmark like LIBOR, the payments may be fixed or variable.
• Dividend Preference: Common stockholders are not entitled to the same dividend payments as preferred stockholders.
• Absentee Voting: In general, holders of the shares do not receive voting rights. Certain preferred shares, nevertheless, provide their owners the ability to vote on unusual occasions.
• Convertibility to Common Stock: A fixed number of common shares may be obtained by converting preferred shares. While some preferred shares have a conversion date specified, others need the board of directors' permission before they may be converted.
• Callability: The issuer may repurchase the shares on certain occasions.

Types of Preferred Stock

One extremely adaptable kind of security is preferred stock. They could be:

• Preferred Stock that is Convertible: The shares are convertible into a certain number of common shares.
• Cumulative Preferred Stock: In the event that a share issuer fails to make a dividend payment, the amount missed will be added to the subsequent dividend payment.
• Preferred Stock that may be Swapped for Other Securities: The shares are exchangeable.
• Perpetual Preferred Stock: The return of the invested capital to the shareholders is not subject to a set date.

Difference Between Common Stock and Preferred Stock

The differences between common stock and preferred stock are as follows:

Conclusion

In conclusion, common and preferred stocks both signify ownership in a firm, but they have different rights and attributes. Preferred stock, on the whole, is less likely to appreciate in value than ordinary stock.

FAQs

Q1. What is the preferred stock calculation process?

A. The preferred dividend is divided by the market price per share to determine the cost of preferred stock. After they've ascertained that rate, they may contrast it with alternative lending possibilities. The Weighted Average Cost of Capital is also computed using the cost of preferred shares.

Q2. What is 7% preferred stock?

A. Consider a company issuing a 7% preferred stock at a $1,000 par value. In turn, the investor would receive a $70 annual dividend, or $17.50 quarterly. Typically, this preferred stock will trade around its par value, behaving more similarly to a bond.

Q3. What's the name for common stocks?

A. For entrepreneurs and investors searching for profitable ventures, common stock-also known as ordinary, voting, or common shares-is an essential topic.

Q4. How do common and preferred stocks vary from one another?

A. Preferred stockholders are compensated first in the event that there are any assets left over when a firm fails, a practice known as preferential treatment. Preferred investors are paid before common stockholders receive their payout.

Q5. Common stock is owned by whom?

A. An individual who has acquired a minimum of one common share in a firm is considered a common shareholder. In addition to being entitled to declared common dividends, common shareholders can vote on corporate matters. Preferred shareholders and debtholders receive payment in the case of bankruptcy, followed by common shareholders.