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Common Stock Vs Preferred Stock

Stocks come in two varieties. "Common stocks" are indeed the most common, hence the name. For most people, the words "stocks" and "common stocks" are nearly synonymous terms. However, there is another type of stock, known as "preferred." While both common and preferred offer ownership shares in a company, there are big differences between the two.

In a nutshell, common stocks offer the greatest reward but at the greatest risk. In theory, common stocks have unlimited upside potential, assuming the company continues to prosper. But investors also could lose their entire investment if the company fails. Common stocks also have voting rights in a company, with one share having one vote.

Preferred Stocks Similar To Bonds

Preferred shares, by contrast, act more like bonds, in that they offer little upside opportunity but pay a guaranteed dividend, often in perpetuity. As a result, the price of a preferred stock is more influenced by the general level of interest rates, not the fortunes of the issuing company. So if interest rates go up, the price of the preferred would likely go down, and vice versa, just as a bond would.

Many common stocks also pay dividends, but their payouts are not guaranteed, and they're usually lower than on preferred stocks. Many common stocks don't pay dividends at all, so price appreciation is the only way for investors to benefit.

Voting Rights

Preferred holders don't have voting rights. However, for most individual investors, having a vote or not is usually of little consequence. Unlike bonds, preferred shares generally don't have a maturity date, but they are usually callable by the issuing company, meaning the company will pay holders a certain fixed price for their shares.

Bankruptcy Treatment

Common and preferred stocks also are treated differently in the event the company fails and has to be liquidated, with preferred shareholders getting preference over common investors, hence the name. Preferred shareholders get paid second, after creditors and bondholders receive their money back.

If any money is left over after those parties are paid, only then do common shareholders get anything. Likewise, if the company misses a dividend payment, preferred stockholders get paid any missed payments before common shareholders receive anything.

Preferred shares are often convertible into the company's common stock, generally at a fixed price or as a percentage of the common's stock price.

Summary

Stocks come in two varieties: common and preferred. Common stocks offer the opportunity of price appreciation, but they also carry the risk that the price will go down or the company will go bankrupt. Preferred stocks, by contrast, are similar to bonds in that they pay a fixed dividend.

Common stocks also pay dividends, but they are not guaranteed and are usually lower than preferred dividends. Common stocks have voting rights but preferred shares don't. Additionally, in the event the company fails, common shareholders are last in line to get their money back, after bondholders and preferred shareholders.