Most investors are familiar with common stock, the shares that typically represent ownership in a publicly traded company. But some corporations also issue preferred stock, a security with features that can resemble both stocks and bonds.
The distinction matters because preferred and common shareholders may have different dividend rights, voting privileges, and claims on company assets.
What common stock represents
Common shareholders generally have an ownership interest in a company and may have voting rights on certain corporate matters. They can benefit when a company's business grows and its share price rises.
Common stock dividends are not guaranteed. A company's board may reduce, suspend, or eliminate them. Common shareholders are also last in line for company assets if a business enters liquidation, after creditors and holders of securities with higher priority.
How preferred stock differs
Preferred stock generally ranks ahead of common stock for dividend payments and claims on assets in a liquidation, but behind the company's creditors and bondholders.
Many preferred shares pay a stated dividend. Some are cumulative, meaning unpaid dividends may accumulate and must generally be addressed before common dividends can resume. Noncumulative preferred shares may not provide the same protection for skipped payments.
Preferred shareholders often have limited or no ordinary voting rights, although special voting rights may apply in certain circumstances.
Fixed payments do not eliminate risk
Preferred stock can appeal to investors seeking income, but its dividend is not the same as a guaranteed bond coupon. A company may face financial pressure, and preferred dividends can be deferred or suspended depending on the security's terms.
Preferred shares can also be sensitive to interest rates. If market rates rise, an existing preferred share with a fixed dividend may become less attractive compared with newly issued securities offering higher yields.
Some preferred shares are callable, meaning the issuer may redeem them under specified conditions. Investors should examine call dates and redemption prices before buying.
Read the terms carefully
Preferred stock is not one uniform product. Terms can include conversion rights, cumulative dividends, call provisions, floating rates, and special voting arrangements.
Investors should review the prospectus or offering documents, the company's financial strength, dividend coverage, and the security's trading liquidity. A high stated yield may reflect higher risk rather than a bargain.
Bottom line
Common stock typically offers greater participation in a company's growth and voting rights, while preferred stock may provide a more structured dividend priority. Neither is risk-free. Investors should compare the security's terms and the issuer's financial condition before making a decision.
Educational disclaimer: This article is for general informational purposes only and is not individualized investment advice.
