Preferred Stock vs. Common Stock: What’s the Difference? | Stash Learn

Preferred vs. Common Stock

Published: Jun 13, 2023

• Updated: Aug 27, 2024

When you invest in a company by purchasing shares of stock on the stock market, you may have the option to choose between preferred stock vs. common stock. While both types of stock grant investors an ownership stake in the company and provide an opportunity for profit, there are some key differences regarding shareholder rights, risk, and potential returns.

Common stocks are, as the name implies, the ones most commonly purchased by investors and most frequently offered by companies. These stocks grant common shareholders ownership rights in the company, and their typical value comes from growth in share price. They’re seen as higher risk than preferred stocks.
Preferred stocks combine characteristics of common stocks and bonds. They pay shareholders a specified dividend and give them priority over common stockholders for receiving dividends, but typically don’t come with voting rights in the company.

By understanding how these two types of stock differ, you’ll be more equipped to decide which makes the most sense for your risk tolerance and investing goals.

What is common stock?

Common stock is a type of security that represents ownership in a company. Common stockholders typically get voting rights in company decisions, usually one vote per share. Some common stocks pay dividends, but the primary way in which investors can earn a return on common stock is through the growth in share price over time.

Common stocks can appeal to investors because they tend to have higher long-term growth potential than preferred stock or bonds and are the most frequently available type of stock. However, this growth potential comes with risk. Common stockholders have the lowest priority for receiving dividends, as well as any payouts if a company liquidates, so the chances of losing your initial investment or not receiving dividends are higher for common than preferred stock.

Types of common stock

Broadly, common stock falls into two categories: voting and non-voting. These are differentiated by the voting rights you get with ownership and typically have a relatively small price differential.

Voting common stock: Investors who hold voting common stock can vote in shareholder meetings, including the option to vote by proxy. This is the most typical type of common stock.
Non-voting common stock: Non-voting common stock is a stock in which the shareholder does not have voting rights. These stocks are usually offered when a company wants to raise new capital from investors without offering control over business decisions.

Pros and cons of owning common stock

Investors generally buy common stock in the hopes of earning a return when the price appreciates or through dividend payments if the company offers them. This comes with higher volatility, higher risks, and higher potential returns than preferred stocks or bonds.

Pros	Cons
Performance: In the long term, common stocks tend to outperform preferred shares and bonds	Risk: Common stockholders are last in line to receive payouts if a company liquidates
Voting rights: Common stockholders have the opportunity to participate in business decisions	Volatility: Value is determined by the open market, and share prices can be volatile
Liquidity: Shares are highly liquid and can be bought and sold at any time	Dividends: Companies are not required to pay dividends on common stock, and when they do, common stockholders are the lowest priority for payout

What is preferred stock?

Preferred stock is a type of equity that shares characteristics with both common stocks and bonds. Preferred stockholders are given preference over common stockholders when dividends are paid and assets are distributed. While they have rights to a company’s profits, they generally have no or limited voting rights in corporate governance.

The most significant appeal of preferred stock to investors is often the higher priority for dividends, making them a good source of predictable income. Dividend payments are prioritized over those for common stockholders, generally yield more, and are generally paid monthly or quarterly.

That said, preferred stock tends to have a lower potential for long-term growth than common stock. Preferred stock is initially priced based on par value, which is the value of the share set by the corporation’s charter, and is not typically related to the value of the company’s common stock being traded on the market. The price of preferred stock is usually tied to interest rates, so it generally changes slowly, making it less volatile but also limiting how much it can increase.

Types of preferred stock

Not all preferred stocks are the same. The different types come with their own advantages and disadvantages that may suit different types of investors and investment goals.

Cumulative preferred stock: This type of preferred stock requires that any dividends missed in the past, like when a company has a negative stockholder’s equity and can’t afford to pay debts for one or more payment periods, are paid out to the cumulative preferred shareholders first. These shareholders are entitled to missed dividend payments before other preferred stockholders or common stockholders receive any payments.
Non-cumulative preferred stock: Non-cumulative preferred stockholders have no rights to unpaid dividends, meaning that if a company misses dividends, these investors will not receive a make-up payment later.
Convertible preferred stock: Convertible preferred stocks allow a shareholder to trade their preferred stock for common stock. This exchange can happen whenever an investor chooses, but once shares are converted to common stock, they cannot be converted back to preferred stock.
Participating preferred stock: Participatory shares guarantee additional dividends should an issuing company meet predetermined financial goals. Investors who hold participating preferred stock are entitled to the same dividends as other preferred stockholders, plus additional profit opportunities.
Callable preferred stock: Callable shares can be bought back by the issuing company at a fixed price in the future, capping the value of the stock.
Adjustable-rate preferred stock: Dividends issued can vary based on a benchmark rate, usually the T-bill rate, and are adjusted based on a predetermined formula, taking place quarterly.
Perpetual preferred stock: Investors with perpetual preferred stock are entitled to a fixed dividend for as long as the company remains in business. These stocks do not have a maturity but can be bought back by the issuer.

Pros and cons of owning preferred stock

Preferred stocks provide predictable passive income through dividend payments and prioritization over common stock. They typically have a lower volatility than common stocks, but the lower volatility also means shares are less likely to gain significant value.

Pros	Cons
Stable price: Preferred stock usually has a more stable price than common stock	Lower capital gains potential: The value of preferred stocks is less likely to go up compared to common stocks
Higher dividends: Preferred stockholders receive dividends before common stockholders, which are typically higher	Voting rights: Preferred shareholders don’t generally have voting rights, so they lack a say in business decisions
Security: Preferred shareholders are paid before common shareholders if a company goes bankrupt	Risk: Preferred stockholders are still paid after bondholders in liquidation cases

Preferred vs. common stock: which is right for you?

Both preferred stockholders and common stockholders gain ownership in a company by purchasing shares. The most significant differences lie in voting rights, dividends, payment priority, and growth potential.

Preferred stock is less volatile than common stock but tends to provide lower long-term returns. Common stock provides significant potential for long-term gains but is also exposed to higher risk.

	Preferred stocks	Common stocks
Definition	A type of equity that entitles the investor to a fixed dividend	An investment that entitles the investor to voting rights and variable dividends
Voting rights	No	Yes, in most cases
Dividends	Yes	Possible; depends on the individual company
Payment priority	Paid before common stockholders	Paid after preferred stockholders
Growth potential	Lower	Higher
Volatility risk	Lower	Higher

Deciding between the two stock types may come down to your risk tolerance, investment time frame, and investment goals. Consider factors such as:

Voting rights: If having a say in decisions matters, common stocks may fit your needs.
Dividends: Preferred stock may suit you if you seek predictable income, while common stock can offer higher returns.
Priority in payment: Preferred stock may be a good fit for stable investments since they are prioritized when companies liquidate.
Risk tolerance: Preferred stocks typically less volatile than common stocks; consider common stock for higher growth potential if your risk tolerance is higher.
Price: Preferred stock often has a lower price and less volatility compared to common stock.
Market conditions: With preferred stocks being paid first in liquidations, they are less risky in uncertain economies, while common stocks benefit more in economic booms.

How to start investing in stocks

Whether you invest in preferred stock vs. common stock depends on your risk tolerance, investment strategy, and goals. You don’t have to choose just one; there may be advantages to owning both types as part of a diversified portfolio.

When you’re ready to start investing, Stash can make it easy with the Stash Smart Portfolio ™, giving you automated investing options tailored to your goals.