What is the difference between preferred and common stock?

It was a miserable gray morning and I was travelling to work on the train. I sat there with my eyes closed and listened to the conversation between the two young men who were sitting opposite. “So what is the difference between preferred and common stock?” the younger one asked. The following is a summary of his answer, which I found most interesting.

Preferred and common stock is shares (units of equity) in a company, which are offered to investors. The difference between preferred and common stock is considerable. Preferred stock, which is sometimes referred to as preferred shares, is normally issued with a number of negotiated rights, which take preference over common stock.

The primary rights that basic preferred stock has over common stock is in the payment of dividends and in the event of liquidation.

Both common and preferred stock have dividends paid on them but the difference between preferred stock and common stock dividends is that dividends due to holders of preferred stock would have to be paid before any declaration of dividends on common stock can be made.

Most preferred stocks pay dividends that have been negotiated at a fixed amount or are a percentage of the price paid by the investor when purchasing the stock. Whereas dividends paid on common stock are tied to the stock market and for that reason can rise or fall depending on the company’s performance. Other dividend rights on preferred stock can allow any negotiated dividend to accumulate year on year if the dividend is not paid but this is not an option that would be available to holders of common stock.

Should a company have to go into liquidation both preferred and common stock have a claim. However, the preferred stock claim would take preference and may have a fixed or negotiated value whereas the common stock would only have what is called a residual claim. This means that a holder of common stock can only claim on those monies remaining after all other costs have been taken care of.

As well as the basic preferred stock, companies often issue other types of preferred stock, for example convertible preferred stock, participating preferred stock etc. Each of these different types of preferred stock has specific rights attached to them.

With regard to voting rights the difference between preferred and common stock is that normally only common stock has voting rights and by using these voting rights can influence the running of the company and elect directors to the board. Occasionally, preferred stock has a negotiated right to voting but this is not normally the case.

I learnt a lot on my train journey and now understood the difference between preferred and common stock.

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