Common Stock vs. Preferred Stock

Stock investors can choose from thousands of companies across various sectors. However, some investors may not know that they can also choose between common and preferred stock. While common stock is more accessible to retail investors, it is also possible to get preferred shares. Understanding the differences between these two shares can help you make better choices for your portfolio.

What Are Common Stocks?

Common stocks fulfill the widely held definition of owning a stock. Common shares let you own a small piece of the company and accumulate wealth if the company performs well. Your shares can appreciate over time, and some stocks also offer dividends. Shareholders can vote on issues related to the company, such as deciding on a new board member. 

Pros:

• Benefit from share price appreciation
• Receive dividends if the company pays dividends
• Vote on company issues
• Get partial ownership of the company

Cons:

• Can lose value if share price drops
• Dividends for common shares often lower than preferred shares
• Less protection if the company has to liquidate

What Are Preferred Stocks?

Preferred stocks do not offer voting rights, and your potential returns have a lower ceiling. Preferred shares are a hybrid of stocks and bonds. These shares have higher yields than common shares and get priority for a dividend. It’s possible for preferred shareholders to receive dividends even if common shareholders do not receive dividends. In some cases, preferred shares can get exchanged for common shares at maturity. The investor’s return is capped to the preferred stock’s par value plus dividend payments. 

Pros:

• Generate higher cash flow
• Lower your risk of significant losses
• Get priority for dividend payments and preference in the event of a liquidation 

Cons:

• Preferred shares rarely give the investor voting rights
• More limited upside

Comparison of Common Stock vs. Preferred Stock

Common stock is riskier than preferred stock but can generate higher long-term returns. Preferred stocks are more optimal for risk-averse investors who want steady cash flow. Preferred stock is similar to a bond, and some preferred shares can get converted into common shares at maturity. 

Preferred shares cater to investors with lower risk tolerances who want to generate more income. Preference for dividend payouts and concerns about bankruptcy proceedings give preferred share investors extra safeguards. People approaching retirement may want to consider the higher safety of preferred shares compared to common shares. Investors seeking a higher possible return while accepting more level of risk may benefit more from common stock vs. preferred stock. 

Factors to Consider When Choosing Between Common and Preferred Stock

Common stock and preferred stock have strengths and weaknesses. These factors can help you decide which type of stock makes the most sense for your portfolio.

Risk Tolerance

Investors with higher risk tolerances may want to invest in common stock. These assets can generate higher returns than preferred shares. However, preferred stock offers more stable returns and has more safeguards in place if the company does not perform as well.

Cash Flow

Investors with preferred shares receive higher dividends than investors with common stock. Preferred shares get the first preference with dividend payments. Investors who need extra dividend income to cover their living expenses or reinvest into other assets may want to consider preferred shares. Investors who value potential appreciation more than cash flow can benefit from common stock.

Voting Rights

Most preferred shares do not give voting rights to their investors. If you want to vote on important decisions, such as who gets to be the next board member, you should invest in common stock.

Market Conditions

Market conditions impact asset prices, but common stock sees greater price swings than preferred shares. Investors who believe the market conditions indicate a bullish trend may want to consider common stock. Bearish investors may perform better with preferred shares.

Company-Specific Factors

Investors should analyze a company before buying its stock, but it takes on an extra layer of importance when deciding between preferred and common stock. Companies that have more financial struggles or decelerating revenue and earnings growth can lose value in the future. Investors who believe in that scenario may benefit from buying preferred stock instead of common stock.

However, if a company has reported strong earnings and has a reasonable valuation, investors may be leaving money on the table by opting for preferred shares. It’s more beneficial to own common stock if a company continues to exceed expectations.

Deciding on the Right Stock Shares

Common stock and preferred stock can help investors achieve their financial objectives. Knowing your long-term goals and what you prioritize can help you decide which type of shares are right for you. Investors have to consider several factors before opting for common or preferred stock. Some investors have a combination of both types of shares in their portfolios.

Frequently Asked Questions