What is the difference between common stock and preferred stock?

Why be common stock when you can be preferred. OK, well does that really matter? What is the difference between the two stocks?

The biggest difference between preferred stock and common stock is that preferred stock is offered to investors, and common stock is to employees, and founders.

Common stock is a sort of sweat equity for given effort. Common stock is ownership in a company, just the basic stock that we are used to trading.

Companies sell common stock through public offerings, and it is traded among investors on the secondary market. Those who hold the stock hope to earn dividends from their share of company profits. However, many profitable companies do not pay dividends, and never intend to do so.

On the other hand, preferred stock like common stock, preferred stock is sold by companies and is then traded among investors on the secondary market. However, preferred stock is less risky than common stock. Therefore, investors can expect less reward.

Preferred stock is rated in a similar fashion to bonds as well. There are rating plans used to help investors make judgments as to whether the underlying company will be able to pay dividends. Should the company default on dividends and declare bankruptcy, preferred stock holders are entitled to assets before common stock holders.

The more obvious gamble is with common stock this is also, why the prices may fall. Unlike some other investment possibilities, investors cannot lose more than their initial investment. The bottom line is that preferred stock is less risky than common stock. It has been designed to provide an income making opportunity for investors while raising capital for the underlying company.

The lowest price per share attributed to the common stock, this is issued to employees because it is with the least tax consequences to those who work to earn the stock.

The highest price per share associated with the stock is issued to cash investors. This choice is important because of tax attributes that cause investors to actually want the highest possible tax basis while not paying any more for the investment than its fair value.

With that in mind, we can look at a few differences and similarities between common stock and preferred stock.

Both represent a piece of ownership in a company, and both are tools investors can use to try to profit from the future successes of the business.

• Holders of common stock have voting rights.
• Preferred stock holders receive fixed dividends.
• Common stocks present the possibility for company growth and capital gains.
• Preferred stock has a constant flow of income.

For the reason that they act similar to bonds, preferred shares are showing the risk of the interest rate. When interest rates rise, preferred stock can drop in value. Preferred shares also tend to move more slowly to the upside than common stock. Most preferred shares are also callable, meaning the issuer can cash in the shares at any time. Finally, preferred shareholders generally do not receive the same voting privileges as the holders of common stock.

Like common stock, the company on its balance sheet as equity; or, an ownership interest records proceeds from the sale of preferred stock.

Because preferred stocks are, in fact, equity instruments, they have three important differences from bonds.

First:
They are junior to the company's debt obligations. Every security that a company issues has a specific ranking order, senior to junior. In the event that the company does not generate enough cash to service all of its debts, this ranking order will determine who receives their payment in times of issues.

Second:
Unlike debt instruments, the company is not legally obligated to make dividend payments to its preferred stockholders. Missing an interest payment on a bond will cause a default because it is a debt.

Third:
Those dividends do not accrue between dividend payment dates. When bonds trade, they trade with accrued interest.

Stocks can be classified into many different categories. The two most fundamental categories of stock are common stock and preferred stock, which differ in the rights that they confer upon their owners. The decision is made from the company in control of the stocks. You will need to know what kind of stock you are wanting.