Equity Essentials: Difference Between Common and Preferred Stock

Key Takeaways

• Preferred stock typically offers no voting rights to shareholders, while common stock typically provides one vote per share owned.

• In the case of liquidation or bankruptcy, the greater claim for a corporation’s assets and earnings belongs to preferred stakeholders.

• A preferred stock’s dividend yield is a dividend’s dollar amount divided by the stock’s price.

Understanding the difference between common and preferred stock can help investors make investment decisions and align their holdings with their financial goals. With that said, here are equity essentials: differences between common and preferred stock.

What is Common Stock?

When it comes to common vs preferred stock, common stock is a type of stock a company issues to raise money. It is the stock type most people buy and represents partial company ownership. Common stock typically provides one vote per share owned. Common stock shares permit investors to share in a corporation’s long-term success.

What is Preferred Stock?

As with common stock, preferred stock is a stock type issued by a company to raise funds. It is a security that represents partial company ownership.

Dividends here are paid to shareholders before the issuance of dividends to common stockholders. Likewise, if a company files for bankruptcy, preferred stockholders are paid from corporate assets before holders of common stock.

What are the Main Differences?

Both stock types represent a piece of company ownership. However, there is a difference between common and preferred stock, including when it comes to:

• Voting rights. Regarding common vs preferred stock, preferred stock typically offers no voting rights to shareholders, while common stock does. Such rights can pertain to board elections or any form of company policy. 
• Liquidation preferences. In the case of liquidation or bankruptcy, the greater claim for a corporation’s assets and earnings belongs to preferred stakeholders.

Convertible Preferred Stock

Considered a form of hybrid investment, this is a type of preferred stock. After a certain date, it can be converted into common stock at a fixed conversion ratio. Convertible preferred stock is commonly offered to venture capitalists — those who invest in startup companies. It combines the equity that results from conversion to common stock with the debt of fixed dividend payments.

How it works is, after a specified time, an investor may convert their preferred stock to common stock. In doing so, they get voting rights and potentially greater returns.

Pros and Cons

As with most everything else in the investment or financial space, there are benefits and drawbacks to common vs preferred stock.

For common stocks, those include:

• Potential for high returns. There is the possibility for capital appreciation.
• Voting rights. Voting rights for corporate directors and policy changes is a feature of common stocks.
• Higher risk. While common shareholders possess more potential for profit, they also are last in line if things sour. In the event of bankruptcy or liquidation, they may wind up with worthless shares.
• Last in line for dividends. The company prioritizes paying preferred stockholders over holders of common stocks.

For preferred stocks:

• Fixed dividends. With preferred stock, dividends are fixed, normally for the stock’s life. 
• Priority over common stock in assets. Investors with preferred stock have priority in claiming corporate assets.
• Limited upside potential. While common stock has unlimited upside prospects, there is a cap on the potential of preferred stock.
• Typically no voting rights. Usually, those with preferred stock may not vote on board members or policy changes.

Dividends Explained

Companies that make regular distributions to shareholders issue dividend stocks, usually in the form of cash. 

Here is what is key to know about preferred and common stock dividends:

Preferred Stock Dividends 

• How they differ from common dividends. The dividend for preferred stock is fixed and guaranteed, while common stock dividends can be discontinued, or change over time.
• Cumulative vs. non-cumulative dividends. The former is a preferred stock class that entitles an investor to missed dividends. Non-cumulative dividends is a preferred stock type with which investors are not entitled to missed dividends.

Common Stock Dividends 

• How they are determined. Dividends are based on factors such as the corporation’s financial performance, operations cash flows, and current and future cash requirements. Dividend per share is the total dividend divided by shares outstanding.

Special Considerations in Startups 

Note that with startups, investors usually negotiate for preferred shares since there are advantages including certain rights and privileges. There are protective elements that lower risk. Meanwhile, founders and employees typically receive common shares.

If the value of a common stock appreciates, the stock may perform well in the long run. However, because dividend income is not guaranteed, common stock poses a risk to stockholders. Such stockholders also come last in liquidation preference.

Strategy for Investors 

Establishing a portfolio of varying asset classes and expected risks and returns is essential to long-term financial success. The practice called diversification is based on the idea that a downward-moving asset can be offset by an upward-moving one.

A diversified portfolio can include common and preferred stocks as well as bonds. It can also include alternative asset classes such as art and real estate, offered by Yieldstreet. Because private-market alternatives have low correlation to public markets, they are generally less volatile. In addition to potentially mitigating overall risk, diversifying can also guard against inflation and improve returns.

 Alternative Investments and Portfolio Diversification

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other alternative investments. 

Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10,000.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

Summary 

When it comes to common vs preferred stock, there are distinct differences – and risks — about which investors must be aware. Key among them are dividends and voting rights.  There also are common ways to strategize around both stock types.

Remember, too, the importance of portfolio diversification and how investors can go beyond stocks and bonds to achieve it.