Difference Between Preferred And Common Stock

Edited by Diffzy | Updated on: April 30, 2023

       

Difference Between Preferred And Common Stock

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Introduction

People who have a job in a different field or who own a business can supplement their income by investing in the stock market. But some make a career out of the stock market by studying the market through technical and fundamental analysis, looking at each parameter for confirmation of whether the stock is a green flag, and taking a potential risk in investing.

Although the first-ever formal exchange is commonly thought to have been a commodities exchange established in 1531 in Antwerp, Germany, where traders exchanged promissory notes and commodities, the Dutch East India Company (EIC) issued the first recorded stock certificate on the Amsterdam Stock Exchange. The Dutch East India Company was created by the States General of the Netherlands in 1602. The EIC was an English company established two years before the Dutch EIC.

In the stock market, there are two types of stocks: common and preferred stocks. Despite both being called stocks, the functionality and operations of both stocks differ completely. Each has different risks and may be suitable for different types of investors. The word "preferred" gives out the suggestion that this stock is more of a popular choice, but there are many common stocks in the market. Nonetheless, any stock can be purchased and sold from any brokerage account. Before we jump to a conclusion, let us first understand something about both the terms and what aspects make them different.

Preferred Stock Vs. Common Stock

The preferred stock was first introduced by the Dutch East India Company in 1602 to the Amsterdam Stock Exchange. The EIC was the earliest business to compete for exports from the spice and slave trades. The charter was granted by the Dutch governing body for such an exchange in a safe and regulated place to buy and sell shares. The charter had immense powers that were amused by local merchants and wealthy families who competed with one another in the spice market.

Later on, the merchant would form a company as a low-liability company, which the investor would fund and for which he would later earn profits. But since the spice supply was unpredictable, there was no guarantee that the given fund would possibly generate profits. Consider that when the spice supply increased more than the demand, the price fell, which affected both investors and merchants. Also, corruption and competition gradually rose with more and more wealth, and the monopolistic hold was dissolved, which also made VOC, the spice supply company, go out of business.

The common stock, as well as the first ever established in 1602 by the Dutch East India Company, was later introduced to the Amsterdam Stock Exchange. For the last 400+ years, the stock market has appeared around the globe, and with each passing year, more and more companies have been listed on a global stock exchange such as NASDAQ, the London Stock Exchange, the Tokyo Stock Exchange, the National Stock Exchange of India, the Shanghai Stock Exchange, and so on.

Top of the list is the New York Stock Exchange, followed by NASDAQ, London, Tokyo, Shanghai, Hong Kong, and so on. Even the BSE and NSE are listed among the top 15, ranking 10 and 11, respectively. Furthermore, the BSE has over 5500 listed companies, while the NSE has over 3700, putting it ahead of the Indian economy as a whole. But from the perspective of market capitalization, it totalled around $53 trillion, which makes the NYSE the biggest stock exchange in the world.

Difference between Preferred Stock and Common Stock in Tabular form

Parameters Preferred Stock Common Stock
Meaning The name "preferred stock" was given to such stocks because, even though they do not get voting rights, they do get preferential profits and dividends. The common stock, or ordinary share, as the name suggests, is the stock investors invest in to get the right to vote and the right to get their profits.
Voting rights The preferred stockholder has no voting rights in any matter affecting the company. The common stockholder has the right to vote and even to submit a proposal if asked for.
Priority The preferred stock owner is prioritized before the common stockholders. And before the preferred stock, debt holder is prioritized.  The common stockholders are not given any priority since they are considered to be the owner of a small part of the company.
Scope The possibility of growth is pretty low. Comparatively, the possibility of growth is very high.
Transferring rights The transfer rights are given to preferred stock. The transfer rights are not given to common stock.
Distribution of Profits & Loss Irrespective of all the losses and profits the company makes, the preferred stockholders get their respective dividends. If the company suffers a loss and there is an event of liquidation, the common stockholder receives no dividend.
Claim on Arrears The arrears of the preferred stock are received a year later. Do not get unpaid debts in the following year.
Dividends distributions The preferred stock holder always receives the dividend at a fixed rate. The common stockholder does not always receive the dividend.

What is a Preferred Stock? 

Preferred stock is also known as preferred equity, preferred share, or even "preferred." Such stock is a combination of features that common stock does not possess. To name a few features, it contains properties of both an equity and a debt instrument, hence being considered a hybrid instrument. Additionally, preferred stock is higher in rank than common stock and subordinate to bonds. In terms of payment on dividends and liquidations, the preferred stockholders have the upper hand over the common stockholders. If such terms and regulations are described in the company's articles of association,

Preferred stock is also rated by credit rating agencies, just like a bond. Furthermore, the ratings are lower than bonds since the preferred dividends are not guaranteed as interest payments from bonds. because preferred stockholders are subordinate to all the creditors. Some preferred stocks do have the special voting rights to approve any events or elect any directors, and if not, some do gain voting rights after preferred dividends are in arrears for a substantial time.

The preferred stock has a fixed dividend amount that is specified as a percentage of the par value. In some cases, the dividend amount is negotiable, which is also known as "floating." At such times, the rate is determined by the benchmark interest-rate index. The average of the interest rate is calculated by taking into consideration the interest rates of 15 banks and, later, the method of trimmed arithmetic mean, in which outlying interest rates are excluded. So, if out of 15 banks, 3 have extreme interest rates, they are excluded, and for the rest, the method is applied.

Sometimes, a company or organisation uses preferred shares as a means of preventing hostile takeovers, which provides the shareholders with some special rights (as aforementioned). In such cases, there is also a discount on the price of the share after some percentages of the shares are bought by shareholders. Consider that 20% of the shares are being bought by the A team, and then they get a discount on the further purchase. Similarly, if the B team agrees to buy the same item, the bid will rise steadily as the competition increases. The process is known as the "poison pill."

There are various types of preferred stocks, to name: prior preferred stock, preference preferred stock, convertible preferred stock, cumulative and non-cumulative preferred stock, exchangeable preferred stock, and so on.

What is a Common Stock?

A common stock known as corporate equity is a type of security. A type of equity ownership to which a debt or liability has attached A term such as "voting share" or "ordinary share" is used outside the United States. The term "equity shares" or "stock" is used in the United Kingdom and other Commonwealth realms. The proprietor of the common stock does have some rights; they can earn profits from the rising price of a stock and can vote on matters of corporate policy and the composition of members of the board of directors.

Additionally, owning common stock does not mean owning a particular asset of the company; at the time of dividends and liquidation, the preferred stockholder has the upper hand over the common stockholder. In any event of liquidation, the funds are first distributed to the bondholders and preferred stockholders, and the remaining funds are further distributed among the common stockholders. And when the liquidation happens during bankruptcy, the common stockholders usually get nothing.

Despite the short-term volatility of common stocks, they do outperform some of the most secure investment policies. As a result, despite being more exposed to business risk, it offers greater potential for capital appreciation.

The owners of the common stockholder rights are pre-defined in the companies' laws and regulations. Those could be votes on matters involving directors, officers, board members, or further plans such as acquisition or dissolution, merger or de-merger, and so on. Some companies even allow the owner to submit proposals to amend the bylaws. They also have the right to request access to the company's financial records, the list of shareholders, the volume of shares being bought and sold, and other required financial records.

The common stock is traded on the exchanges and can be bought and sold by investors. The various types of common stocks are growth stocks, large-cap stocks, small-cap stocks, income stocks, value stocks, penny stocks, and so on. The investor or trader must differentiate the portfolio for better outcomes from each type of common stock.

Main Difference Between Preferred Stock and Common Stock in Points

  • To begin with, the difference is that let's consider what the inheritance of each stock means: the preferred stock comes with the profits of earning dividends but no right to vote and the common stock comes with both earnings from dividends and voting rights. But there is a catch and potential risk while earning from the common stock, which lacks preferred stock.
  • Additionally, as aforementioned, the preferred stockholder does not get the right to vote on any of the company's matters, such as future expansion, dissolution, merger, and many other matters. The common stockholder has the right to vote on such matters of the company, and some companies even allow the stockholder to send several proposals if need be.
  • Furthermore, in the event of liquidation, priority is given to the preferred stockholder, and the funds and dividends are first transferred to them. If any funds are left over, they are distributed to common stockholders.
  • In case of a claim, the preferred stock owner receives the arrears in the following year. On the contrary, common stock arrears are not received in the following year.
  • The possibility of growth seems to be higher in the common stock. Long-term profits are associated with potential short-term volatility and risks. The profit that could be earned from common stock is a lot more than that from preferred stock in the long run. Hence, the possibility of growth in the preferred stock is lower.
  • Just like a bond can be transferred from one owner to another, preferred stock is also made with the provision of transfer. If one owner intends to transfer the preferred stock to another interested participant, they can do so. The same is not possible with common stock, as there are no rights to transfer.
  • In cases of bankruptcy and losses, the preferred stockholders still receive their respective dividends. In similar circumstances, the common stockholders do not receive the dividends but rather suffer the losses if they have not applied the stop loss in their analysis.
  • There are a greater number of common stocks available in the market than there are preferred stocks.

Conclusion

To conclude, after learning the differences and their operations, one must be able to choose the stock that fulfils their requirements. If you need immediate money, the preferred stock is the right option, and if you want to keep money invested in the stock for the longer run, then invest in the common stock.

Although the money required for preferred stock is a bit more than that of common stock, there is the assurance of earning profits from the dividends irrespective of the company's losses. In general, common stock is more bought and sold in today's market because it can be used to make short-term profits if you are wealthy and have a technical and fundamental knowledge of the stock market. 

References

  • Common Stock vs Preferred Stock | Top 8 Differences (wallstreetmojo.com)
  • Common Stock vs. Preferred Stock: What's the Difference? | Nasdaq

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"Difference Between Preferred And Common Stock." Diffzy.com, 2024. Mon. 17 Jun. 2024. <https://www.diffzy.com/article/difference-between-preferred-and-common-stock-1131>.



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