Common Stock vs. Preferred Stock: What’s the Difference?

Preferred Stock is a very different creature from what is generally referred to as common stock. Common stock is what most investors think of when they purchase stock. It really is the most “common” type of stock traded. Stock is that equity in a company that an investor purchases. Preferred stock is quite the opposite. Preferred stock is ownership within the traded company, but with added perks. It is almost like a bond, with guaranteed rights to a company’s assets if the firm were liquidated.

Preferred stockholders have a greater claim to the firm’s assets than common stockholders do. For this reason, when dividends are paid, the claims from preferred stock are paid first – before any dividends are paid to common stock claims. This difference in classification is most essential during times of insolvency by the firm, however. If a company were to be liquidated, preferred stockholders are paid before common stockholders get a single penny.

Also, the dividends that are paid to preferred stocks are quite different from common stocks. Dividends are generally paid at regular intervals, not intermittently when a company’s board decides to, which is commonly how dividends for common stock are paid. Oftentimes these dividends are guaranteed by the firm.

So with all these added perks to common stock what are the disadvantages? First off, preferred stock is not issued by every publicly traded company. The cost of raising capital through preferred stock for a firm is 35% greater than through issuing bonds because the dividends paid are not tax deductible. Preferred stock represents a fraction of the total stock market in the US at around $200 billion in August 2006, compared to $16 trillion for equities and $5 trillion for the bond market. Also, there are corporate tax advantages available to corporate ownership of preferred stock that can never be realized by individuals. For this reason, it is common to see corporations snapping up preferred stock issuances.

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