Trillionaire Term of the Day - February 19, 2009 - CS vs. PS

Common Stock vs. Preferred Stock

Common stock and preferred stock both represent partial ownership of a company. While both variations serve a similar purpose, there are key differences that distinguish the two forms of stock.

The biggest distinction between the two is priority of dividend payments. Dividends are paid out to preferred stockholders before common stockholders. Additionally, if a company goes bankrupt, the preferred shareholders have priority in the distribution of a liquidated company’s assets. If a company goes under, the preferred shareholders will usually get a piece of the assets and common shareholders will be left in the dust.

Common shareholders have voting rights that go along with holding common stock. For each stock they hold, they get one vote for various types of decisions. Examples of issues that companies use votes for include approval of stock splits, election of board members, and support of general company movements. Preferred stockholders don’t have the right to vote. Those that hold preferred stock sacrifice the right to vote for priority in dividend payments.

In general, investing in preferred stock is less risky than investing in common stock. The fluctuation of preferred stock prices is based mostly on changing interest rates, while the rise and fall of common stock prices is based on investor demand for the stock. This means that common stock prices will be much more volatile than preferred stock prices. Buying preferred stock can be a great method of defensive investing, as investing in preferred stock instantly adds stability to your portfolio. You can avoid the volatility that goes along with common stock and guarantee dividend payments in harsh times.

With this said, it’s important to know that common shares are true to their name… they are much more common than preferred shares. When you see a stock on a ticker or look at a stock index, you are looking at common stock.  At this point in your investing career, when you consider buying shares of a company you will generally be buying common shares.  Nevertheless, it’s important to understand the difference between common shares and preferred shares if you will be investing in either variation.

Matt Schwartz

College Trillionaire