Common stock and preferred stock are the two major types of stock one can purchase from a corporation. Common stock are shares that represent ownership in a corporation and have a claim on a part of the profits which is paid out in the form of dividends. Common stock investors receive one vote for every share they own. These votes are used to vote on the corporation’s policies and to elect the board of directors. In the event of a bankruptcy and liquidation, common shareholders are not until after the corporation’s preferred shareholders, bondholders and creditors are paid. The advantage to owning common stock is that this form of investment generally outperforms both preferred stock and bonds.
Preferred stock also represents ownership in a corporation, but the same voting rights do not come with it. Investors are guaranteed fixed dividends forever. Dividends on common stock are not guaranteed and are variable. Preferred stock has some of the attributes of both equity (the potential for capital appreciation) and debt (fixed dividends).
If the company is liquidated, preferred shareholders are paid before common shareholders, but after debt holders. Preferred stock can also be callable. This means that the corporation has the right to purchase preferred shares back from the stockholders at any time, usually at a premium.
The advantages to preferred stock is that there is a priority given to preferred shareholders over common shareholders in the event of liquidation and preferred shareholders also receive fixed dividends. The disadvantages are the lack of voting rights and the fact that their is potential for capital appreciation.
There can also be different classes of stock. For example, Class A stock may hold more voting or dividend rights than Class B stock. Corporations have been able to create different classes of stock since 1987.
When choosing which type of stock to invest in, an investor will need to weigh the advantages and disadvantages of each type of stock. Common shares provide the most potential for capital appreciation and also come with voting rights. However, if the company ends up liquidating they are the last to be paid. Therefore, common stock carries more risk but also more reward. For those who prefer a more stable investment, preferred stock may be more beneficial. They provide a steady source of dividend income and are higher in priority than common stock in the event of a liquidation. However, the stability and priority status comes with fewer voting rights and less opportunity for capital appreciation.