Common Stock vs. Preferred Stock
KEY POINTS
Preferred stocks possess attributes shared with common stocks and bonds
The stock type will determine your voting control, participation in corporate actions, priority claim on assets, taxation, conversion potential, and more
A company’s common stock and preferred stock may perform very differently due to their differentiating features
The investment choice between common stock and preferred stock may impact your voting rights, income earned, taxation, investment time horizon, liquidation proceeds, and more. Therefore, we have outlined the key differences to help ensure you choose the right type of stock for your short-term and long-term investment goals.
As always, we recommend you consult your financial advisor before making any investment decisions. An investment in common stock or preferred stock can be very risky and such may not align with your risk tolerance or investment objectives.
Preferred stocks are equity securities that exhibit properties of both debt and equity and their rights rank higher than common stock. Each company determines the attributes associated with its preferred share issuance. Therefore, comparing preferred stocks is not always an apples-to-apples comparison.
The key attributes are highlighted in the following charts. Such highlights are based on the general nature of the two instruments: individual securities may have different attributes (e.g., common stock performance is usually more volatile than preferred stock, but such may not always be the case).
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Ownership and Voting Rights |
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Common |
Preferred |
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Voting rights |
Voting rights, if any, are limited to matters directly related to the preferred shareholders’ interests |
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Elect the board of directors which provide the company’s strategic leadership |
Do not elect the board of directors |
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Vote or influence on matters pertaining to bond issuances, share buybacks, mergers and acquisitions, spin-offs, changes to the company’s bylaws |
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Dividends |
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Common |
Preferred |
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Eligible to receive dividends, if declared by the company |
Receive fixed dividend payments at predetermined intervals that often exceed the rate paid to common shareholders |
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Payments are subordinate to preferred shareholders |
Payments take precedence over common shareholders. Dividends may be cumulative in nature; therefore, the cumulative unpaid dividend balance is paid, if applicable, before common shareholders are paid. |
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Potential exists for declaration of stock dividends providing existing shareholders with increased ownership |
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Liquidation / Bankruptcy |
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Common |
Preferred |
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Ranked last to receive assets, if any, upon liquidation |
Typically entitled to receive their initial investment back and all cumulative unpaid dividends (if applicable) before the common shareholders recover the remaining net assets, if any |
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Risk and Return |
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Common |
Preferred |
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Higher risk / return profile than preferred stock |
Lower risk due to fixed dividend payment and priority over common stock in the event of liquidation |
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Higher volatility |
Lower volatility |
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Lower return than common stock is typical |
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Typically, more sensitive to interest rates than common stock |
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Shares may have a callable feature allowing the holder to redeem the shares at a predetermined price |
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Other |
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Common |
Preferred |
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Capital appreciation is tied to company performance and overall market volatility |
Capital appreciation is highly correlated to an inverse relationship with interest rates |
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Potential to benefit from stock splits and share buybacks (e.g., increased liquidity) |
May provide unique diversification benefits as the security has elements of both debt and equity |
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Generally, more actively traded and offer greater liquidity |
Higher probability of consistent income |
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Broader investor base as stock is more widely available |
Potential tax benefits related to the nature of the dividend income and jurisdiction of investor |
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Ability to participate in corporate actions including mergers, acquisitions, and spin-offs |
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BOTTOM LINE
Common stock and preferred stock share some attributes; however, their differences are substantial. Investors should work with their financial advisors to ensure they appreciate the potentially significant differences related to voting rights, investment risk, income, taxation, liquidity, and more.
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