Preferred Stock vs. Common Stock: Which is the Better Investment Option?
Introduction to Preferred Stock and Common Stock
When investing in the stock market, there are two main types of stocks: preferred stock and common stock. Preferred stock is a type of stock that gives shareholders priority over common shareholders to receive dividends and assets in case of bankruptcy. Common stock, on the other hand, is a type of stock that represents ownership in a company and gives shareholders voting rights.
The main difference between preferred and common stock is the priority given to shareholders regarding dividends and assets. Preferred shareholders have a higher priority than common shareholders when it comes to receiving dividends and assets in case of bankruptcy. However, common shareholders have voting rights and can participate in company decision-making.
Preferred Stock
Advantages of Investing in Preferred Stock
One advantage of investing in preferred stock is higher dividend payments. Preferred shareholders typically receive higher dividend payments than common shareholders. This is because preferred shares have a fixed dividend rate, which means that the dividend payment is predetermined and does not fluctuate based on the company’s performance.
Another advantage of investing in preferred stock is the priority in receiving dividends and assets in case of bankruptcy. If a company goes bankrupt, preferred shareholders have a higher priority than common shareholders regarding receiving assets. This means that preferred shareholders are more likely to receive compensation for their investment.
Finally, preferred stock is less volatile than common stock. This means that the price of preferred shares tends to be more stable than that of common shares. This makes preferred shares a good option for investors looking for a more stable investment option.
Disadvantages of Investing in Preferred Stock
One disadvantage of investing in preferred stock is the limited potential for capital appreciation. Unlike common shares with the potential for significant capital appreciation, preferred shares have a more fixed or stable price that does not fluctuate much.
Another disadvantage of investing in preferred stock is less liquidity than common stock. It may be more difficult to buy and sell preferred shares than common shares. This can make it more difficult for investors to exit their investment if they need to do so quickly.
Finally, there is a higher risk of interest rate changes affecting the stock’s value. Because preferred shares have a fixed dividend rate, changes in interest rates can affect the value of the stock. If interest rates rise, the value of preferred shares may decrease.
Common Stock
Advantages of Investing in Common Stock
One advantage of investing in common stock is the potential for higher capital appreciation. Unlike preferred shares with a fixed price, common shares have the potential for significant capital appreciation if the company performs well.
Another advantage of investing in common stock is more liquidity than preferred stock. This means buying and selling common shares is easier than preferred shares. This makes it easier for investors to exit their investment if they need to do so quickly.
Finally, common shareholders have voting rights and can participate in company decision-making. This means common shareholders have a say in how the company is run and can influence important decisions.
Disadvantages of Investing in Common Stock
One disadvantage of investing in common stock is higher volatility and risk. Because the price of common shares can fluctuate significantly based on the company’s performance, a higher risk is associated with investing in common stock.
Another disadvantage of investing in common stock is lower dividend payments than preferred stock. While some companies do pay dividends to common shareholders, these payments are typically lower than those paid to preferred shareholders.
Finally, common shareholders have a lower priority than preferred shareholders when it comes to receiving dividends and assets in case of bankruptcy. This means that common shareholders are less likely to receive compensation for their investment if a company goes bankrupt than preferred shareholders.
Comparing Preferred Stock and Common Stock
When choosing between preferred stock and common stock, several factors must be considered. One factor is the investor’s investment goals. If an investor is looking for a more stable investment option with higher dividend payments, preferred stock may be better. If an investor is looking for the potential for higher capital appreciation and voting rights, common stock may be a better option.
Another factor to consider is the company’s financial situation. If a company is financially stable and has a good track record of paying dividends, preferred stock may be a good option. If a company is growing rapidly and has the potential for significant capital appreciation, common stock may be a better option.
Finally, it is important to consider the risk level associated with each stock type. Preferred stock is generally less risky than common stock but has less potential for capital appreciation. Common stock has more potential for capital appreciation, but has higher volatility and risk.
Examples of companies that offer both preferred and common stock include Coca-Cola, General Electric, and Verizon.
Conclusion: Which is the Better Investment Option?
Ultimately, deciding between preferred and common stock depends on individual investment goals and risk tolerance. Preferred stock may be a better option for investors who are looking for a more stable investment option with higher dividend payments. Common stock may be a better option for investors who are looking for the potential for higher capital appreciation and voting rights.
When making an investment decision, it is important to consider factors such as the company’s financial situation, level of risk, and investment goals. By carefully considering these factors, investors can make an informed decision about whether to invest in preferred or common stock.
Dr. Lincoln C. Wood teaches at the University of Otago in New Zealand. He is an avid investor and educator. He loves cash flow, income, and dividends when investing. He likes to buy undervalued companies with strong advantages and earnings growth.
