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What is the Difference between Common and Preferred Stock?

When most people refer to investing in stocks, they are usually talking about owning common stock. Both common stocks and preferred stocks represent an ownership stake in a company, have the ability to pay dividends and trade on an exchange. But this is primarily where the similarities end.

With common stock, shareholders can participate in the growth of a company through the price appreciation of the shares. Shareholders also receive voting rights on company issues including selection of the board of directors.

Preferred stock, on the other hand, can be seen as a hybrid product between stocks and bonds as they are equity, but share some of the characteristics of a bond. For example, like bond owners, shareholders of preferred stock do not have voting rights. However, in the event of a bankruptcy and subsequent liquidation of the business, preferred stockholders are paid before common stockholders (but after bondholders).

With preferred stock, there is often a guaranteed fixed dividend paid at regular intervals. When a company decides to pay a dividend, preferred shareholders are paid the fixed dividend before common shareholders. In cases where preferred stock is deemed “cumulative,” companies need to make up any missed dividend distributions to preferred shareholders before common shareholders are entitled to a dividend payment.

With their fixed dividend payments, preferred stocks tend to act like bonds and are rated like bonds by the credit ratings agencies. Additionally, the price of the preferred stock depends on how the yield generated by its dividend compares to the interest rate. If the preferred stock’s yield is less than the interest rate, the price will fall and vice versa.

Jemma Everyday Wisdom: Preferred stock investors tend to be more interested in the steady income they receive from dividends, while common stock investors tend to prefer the ability to achieve capital appreciation as a company grows.

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