Common Stock vs Preferred Stock: Understanding the Differences

Common stocks represent ownership in a company, offering voting rights and the potential for significant growth. These equity instruments allow shareholders to vote on corporate matters, such as board elections, making them integral to company governance. Companies issue these shares to raise capital, and their value often grows over time, appealing to long-term investors seeking wealth accumulation.

Common stock and preferred stock are the two types of stock that are most often issued by publicly traded companies and they each come with their own set of pros and cons. Let’s say you have a choice between investing in preferred stock or common stock of a company you have your eye on. It can all come down to your investment goals and your personal concerns. When interest rates rise, the value of the preferred stock declines and vice versa. The price of preferred stock is normally less volatile than the price of common stock.

However, this potential for higher returns also brings greater volatility, which might not be suitable for every investor. This setup offers preferred shareholders both the stability of fixed dividends and the possibility of capital gains through conversion. Conversion rights offer unique flexibility for investors in certain types of preferred stock, allowing them to convert their preferred shares into common shares under specific conditions. Common stock represents ownership in a company and offers investors the potential for long-term growth.

Larry Frank is an accomplished financial analyst with over a decade of expertise in the finance sector. He holds a Master’s degree in Financial Economics from Johns Hopkins University and specializes in investment strategies, portfolio optimization, and market analytics. Renowned for his adept financial modeling and acute understanding of economic patterns, John provides invaluable insights to individual investors and corporations alike. His authoritative voice in financial publications underscores his status as a distinguished thought leader in the industry. Preferred shares can also be converted to a fixed number of common shares, but common shares cannot be converted to preferred shares.

However, common stockholders receive dividends only after preferred stockholders, making their income less predictable. This distinction highlights the trade-off between control and stability when choosing between these two investment options. The better choice for an investor depends on their financial goals; common stock offers the highest growth potential, while preferred stock provides safer, fixed-income returns.

Common Stock vs. Preferred Stock: Understanding the Differences

Conversely, should interest rates rise, shares likely won’t be redeemed and the issuer will continue paying the lower rate. Although less risky than common stock, preferred stock has its own set of risks. For starters, the company may cut or suspend dividend payments if it’s facing financial problems. For example, during economic downturns, common stock prices may drop by 20-30%, while preferred stock values remain relatively stable. Conversely, in booming markets, common stockholders benefit from significant price appreciation. A report by Morgan & Partners (2021), “Volatility in Equity Markets,” highlights these dynamics.

• They elect the board of directors, vote on management compensation, and approve major transactions.
• This predictability is a major feature of preferred stock and often attracts buy-and-hold investors focused on a long-term strategy designed to accumulate dividend income.
• Although less risky than common stock, preferred stock has its own set of risks.
• Investors in preferred stocks experience the safest market fluctuations.

Adam Kramer manages Fidelity® Multi-Asset Income Fund (FMSDX), which invests in preferred stocks. Kramer also co-manages the Fidelity Preferred Securities & Income ETF (FPFD) along with Brian Chang and Rick Gandhi. He currently sees opportunities in the preferred stocks of investment-grade US utility companies, master limited partnerships (MLPs) that own oil and gas pipelines, and big US banks. The median yield of preferred stocks according to the Fidelity Preferred Security Screener as of March 31, 2025, is 6%. Kramer has found yields as high as 7% in what are called fixed-to-floating rate preferreds whose interest rates can rise over time. When it’s time for dividends to be paid out, investors who own preferred stock are first in line, ahead of common stock shareholders.

Risk-Return Profile and Market Trading Characteristics

The short answer is that preferred stock sits squarely in between debt financing (i.e., corporate bonds) and equity financing (i.e., common stock), offering attributes of each. For example, if a company issues preferred shares, the dividend pay-out remains fixed. The rate is usually higher than the dividend pay-out ratio of common stockholders. While there are differences between preferred stock vs. common stock, one isn’t necessarily better than the other.

Analyzing the differences will help you identify the better choice for your startup and investors. Preferred stock can attract investors by offering fixed dividends and liquidation preferences, making it an excellent option without diluting the founders’ control. When Roku had its IPO in 2017, a venture lender held a warrant for 400,000 shares of Roku’s preferred stock with a strike price of common stock vs preferred stock $9.17. The lender exercised the warrant, resulting in a net gain of $2.6 million. This shows how preferred stock can significantly benefit investors during a liquidation event. Convertible preferred stock can be converted into common stock at a later date.

• It may not be used for the purpose of avoiding any federal tax penalties.
• However, in some cases, companies may issue multiple share classes, often called Class A, Class B, and Class C shares, for example.
• By offering different types of stock, companies can tailor their equity positions to suit their needs.
• So, common stockholders have a vital role to play in helping a company perpetuate.
• Do you have a stake in the company, emotionally or otherwise, so you want some control over certain aspects of its management?

Which Stock Has Dividend Priority: Common Or Preferred?

The best approach is to go for a portfolio of common stocks to mitigate the risks and to earn a decent income from common stocks. A private held company needs to become public to be able to issue common stocks. That’s why they need to conduct an initial public offering (IPO) to go public and become registered in a valid stock exchange. Dividends from both preferred and common stock may be taxed differently, depending on whether they qualify as qualified dividends or ordinary income.

The opinions expressed and the materials provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. The stock’s prospectus (a document containing investment details) lays out conversion specifics in this case. When you buy common stock, you become a shareholder, essentially a part-owner of the company. Going back to the example, if Company A misses the $2 dividend for preferred shares in Quarter 2, they will need to pay $4 ($2 x 2) in Quarter 3. The company might choose to do this if they decide the interest rates they’re required to pay are too burdensome.