Generally, when someone buys shares in a company, they're purchasing common shares. However, companies may also choose to offer preferred stock. While both types of shares represent ownership in a company, they have fundamental differences. Here are three things you should know about common vs. preferred stock.
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1. Voting rights
With common stock comes the ability to vote on company matters, including members of the board of directors, mergers and acquisitions, dividend amount, executive salaries, and more. Each share usually receives one vote, so an investor with 100 shares would get to cast 100 votes. Preferred stock shareholders, on the other hand, don't have voting rights.
Voting rights are important to many investors because it ensures their voice is heard regarding company affairs. It also helps ensure that a company operates with its investors in mind and not just in the interest of executives or founders. And while a company can technically offer non-voting common stock, it's uncommon.
2. How profits are distributed
Both preferred and common stock have a right to a company's profit, but they're prioritized differently. With preferred shares, investors receive a set dividend amount at regular intervals. As long as the company is in good financial standing, they can expect that payout. If, for some reason, a company can't pay its dividend in a period, it will have to make it up before it can pay dividends to common stock shareholders. For example, if a company has a $3 dividend but has to skip a payment, the next period, they will owe preferred stock shareholders $6.
The dividend payment given to common stock shareholders is determined by its board of directors and fluctuates with the company's performance. The more profitable a company, the higher the dividend is likely to be. Not all companies offer dividends, but if a company does and performs well over time, the upside potential is virtually unlimited. Unfortunately, the opposite is also true; if a company performs poorly or isn't profitable, it may pay nothing.
3. What happens during liquidation
If a company has to liquidate -- whether by being sold or selling all of its assets -- there's a hierarchy in which investors are paid out. Preferred stock shareholders usually get paid first, followed by bondholders and common stock shareholders. What preferred stock shareholders may give up in upside potential, they make up for by gaining a greater sense of security if a company doesn't perform well.
Decide based on investing goals
Whether or not you should buy common or preferred shares comes down to two things: availability and your investing goals. Most companies only offer common stock, so if you're interested in preferred stock, you'll want to first check that the company you want to invest in offers it as an option. If you find a company that offers both common and preferred stock and you can't decide between them, try considering your risk tolerance.
If you're interested in a higher upside and chance for greater profits -- and comfortable with the higher risk involved -- you'll likely want to consider common shares. If you'd prefer to eliminate some risk and focus on consistent income you can count on, you'll likely want to consider preferred shares. As with anything investing-related, do what makes you feel comfortable.
