Learn The Stock Market Lesson – Common VS. Preferred Stocks! Which one should YOU buy?
Many companies issue 2 different types of stocks: common stocks and preferred stocks. Common is definitely not a derogatory term as one might think. Common just means that it is the standard one that the company issues. Likewise, the name “preferred” does not mean that these shares are better, but rather it offers investors privileges and rights different from those offered by common stock. The main differences between the two are the levels of risk and privileges involved.
Common stocks, also referred to as voting shares or ordinary shares, is considered to be more risky and speculative than preferred stock because they are the last priority for ownership structure, should a company go out of business. This means that they are paid after all the other creditors, preferred stockholders and bondholders if a company goes bankrupt. They are last to receive interest and dividends. An advantage is that due to what is called preemptive right, common stockholders have the first right to purchase any new shares of common stock the firm decides to issue before any non-holders. Another advantage is that common stock provides voting rights on matters of corporate policy. Shareholders’ voting rights are based on one vote for each share of stock held. However, they cannot vote on dividends.
Common stock shareholders can be paid dividends variable with the company’s growth. For example, the company’s board of directors will decide whether or not to pay out a dividend. When a company makes profit, after tax, retained earnings may be distributed to shareholders as dividends. If you are one to take this risk, you could receive a great increment of dividends.
Preferred stocks, also called hybrid investment, tend to be more expensive but do not fluctuate as often. It is a more stable investment because it guarantees a regular dividend that is not directly fixed to the market, like the common stock. That means that if the company grows, you would receive the same amount of dividends. You should buy preferred stocks if you want to have priority and have a greater claim on the company’s assets. Even though preferred stockholders are paid before stockholders, they are paid after bondholders. Preferred stockholders do not enjoy voting rights. They can only vote on certain issues such as if the company wants to merge, liquidate asses, or issue more bonds or preferred stocks.
There are 4 types of preferred stocks:
1) Cumulative preferred stock – Guarantees an investor that if one or more dividends are not paid, the missed dividends will be accumulated. All the dividends must be paid in full before any common stock dividends can be distributed.
2) Noncumulative preferred stock – Any dividends missed are lost to the stockholder.
3) Participating preferred stock – You receive extra dividends when a company does well.
4) Convertible preferred stock – Allows you to convert a certain number of preferred shares to common shares.
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The opposite extreme of this is those traders who spend their life looking for the Holy Grail of trading! Been there, done that!