Preferred Stock vs. Common Stock: Which Is Better for You?

When it comes to investing in the stock market, two major types of stocks you might encounter are preferred stock and common stock. Each has its unique features and benefits, making it crucial to understand their differences to make an informed decision that aligns with your financial goals and risk tolerance.

1. The Basics of Common and Preferred Stock

Common Stock: This is the most common type of stock investors purchase. It represents ownership in a company and comes with voting rights, usually one vote per share. Common stockholders have the potential to benefit from capital gains if the company performs well, but they are last in line during liquidation events, receiving any remaining assets after all debts and preferred stockholders are paid.

Preferred Stock: Unlike common stock, preferred stock does not typically come with voting rights. However, it has a higher claim on assets and earnings. Preferred stockholders receive dividends before common stockholders and have a higher claim on assets in the event of liquidation. These dividends are often fixed, making preferred stock somewhat similar to a bond in terms of income stability.

2. Key Differences Between Preferred and Common Stock

• Dividends: Preferred stockholders usually receive fixed dividends, which can be a significant advantage during times of market volatility or economic downturns. Common stock dividends, on the other hand, can vary and are not guaranteed. Companies may choose to pay high dividends, lower dividends, or no dividends at all based on their profitability and other factors.

• Voting Rights: Common stockholders generally have voting rights in shareholder meetings, which can influence company policies and decisions. Preferred stockholders typically do not have these rights, which means they have less say in the company’s operations but receive other benefits in return.

• Claim on Assets: In the event of liquidation, preferred stockholders have a higher claim on assets than common stockholders. This means they are more likely to recover some of their investment if the company goes bankrupt.

• Price Volatility: Common stocks tend to be more volatile and can offer higher returns during bull markets, but they also come with higher risk. Preferred stocks are generally less volatile and offer more stable returns, which can be appealing to risk-averse investors.

3. When to Choose Preferred Stock

Preferred stock might be the better choice if you value steady income and lower risk. It is particularly suitable for income-focused investors who prefer regular dividend payments and are less concerned with the company's growth prospects. Preferred stock can also be a good option if you are looking for a more stable investment that provides a higher claim on assets compared to common stock.

4. When to Opt for Common Stock

Common stock could be preferable if you are looking for growth potential and are willing to accept higher risk for the chance of higher returns. Common stock is often favored by investors who believe in the long-term growth of a company and want to benefit from its success. If you want to have a say in the company’s future through voting rights, common stock would be the way to go.

5. Real-World Examples

To illustrate the differences, let’s consider two well-known companies:

• Company A (Common Stock): Suppose Company A has had a history of significant stock price appreciation and offers moderate dividends. Investors in Company A’s common stock benefit from potential price increases and capital gains, which could result in higher returns over time. However, the dividends are not guaranteed and could fluctuate based on the company’s performance.

• Company B (Preferred Stock): Company B offers preferred stock with fixed dividends and a higher claim on assets. Investors in Company B’s preferred stock enjoy predictable income from dividends and a more secure position in case of liquidation. However, they may miss out on the potential high returns if the company’s stock price rises significantly.

6. Factors to Consider

When deciding between preferred and common stock, consider the following factors:

• Investment Goals: Are you seeking income stability or growth potential?
• Risk Tolerance: Are you comfortable with higher risk for potentially higher returns?
• Company Performance: How is the company performing and what are its future prospects?
• Dividend Preference: Do you prefer regular income or are you willing to forego dividends for potential capital gains?

7. Conclusion

There is no definitive answer to whether preferred stock or common stock is better; it largely depends on your individual investment objectives and risk tolerance. Preferred stock offers fixed dividends and a higher claim on assets, making it a stable choice for income-focused investors. Common stock provides growth potential and voting rights but comes with higher risk and price volatility.

To make the best choice, evaluate your financial goals, risk appetite, and the specifics of the companies you are considering. By understanding the unique benefits and risks associated with each type of stock, you can make an informed decision that aligns with your investment strategy.