Companies require funds every now and then for daily expenses, expansion, hiring staff, expanding product lines, etc. They may fulfill their finance requirements by taking loans or issuing securities to the general public. Common stocks and preferred stocks are two financial securities by which companies may raise funds.
This article guides on common stocks, the meaning of preferred stocks, the types of preferred stocks, and the difference between common stocks and preferred stocks.
What Are Common Stocks?
Common stocks, typically known as equity shares, refer to financial security that represents partial ownership in the company and provides the holder with voting rights for company matters.
Voting rights mean the common stockholders have a say in the company’s major decisions. Plus, equity shareholders are the ones who choose the board of directors, i.e. a team that will manage the company on behalf of investors, using their voting rights.
There are two ways common stockholders may get returns from common stocks – dividends and capital appreciation. Dividends are part of the profit companies distribute to shareholders as a reward; however, it is not compulsory for companies to pay dividends.
Stocks are traded on the stock exchange, and their market prices increase or decrease according to the market’s demand and supply. If the market price of an equity share at the time of selling is higher than the purchase price, the difference is the capital appreciation for the investor.
Advantages And Disadvantages Of Common Stocks
| Advantages | Disadvantages |
| Potential for greater returns | Prone to market risks |
| Voting rights | Uncertain returns |
| Higher liquidity | Ranked last in dividend payments and repayment in case |
What Are Preferred Stocks?
Preferred stocks, also known as preference shares, are similar to common stocks in some ways, as they represent partial ownership and are traded on the stock exchange. They also possess some features of debt securities. For instance, they regularly pay dividends at a fixed rate to preferred stockholders.
Such shares are known as preference shares because preference shareholders get priority over common stockholders regarding dividend payment and repayment in case of company liquidation. However, they don’t possess voting rights and therefore do not have much say in company matters.
For companies, the cost of preferred stock may be lower than common stock.
Advantages And Disadvantages Of Preferred Stocks
| Advantages | Disadvantages |
| Priority in payments over equity shareholders | No voting rights |
| Relatively stable returns | Lower probability of significant returns |
| Some offer option to be converted into equity shares | – |
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Types Of Preference Stocks
1. Cumulative preference shares
The dividend is a part of the profit, and there are chances that a company may not mark profit in some years. Cumulative preference shares require the companies to pay cumulative dividends in the coming year when they incur profit, in case there are any unpaid dividends.
Let’s understand it with an example. Suppose a company issued cumulative preference shares of ₹1,500 each and promised to pay an 8% dividend yearly. In the first year, the company paid a dividend of ₹120 per share.
In the second year after the issue, the company incurred a loss and couldn’t pay dividends. Therefore, when it marked profits in the third year, it paid a dividend of ₹240 (₹120 for the current year + ₹120 for the last year) per share.
2. Non-cumulative preference shares
Non-cumulative preference shares are those types of preference shares in which the shareholders do not get accumulated outstanding dividends for the years when there are insufficient profits. In other words, the investors only get dividends for those years when the company records profits.
3. Convertible preference shares
Convertible preference shares are those in which the holder gets the right to convert them into equity shares after a specific time mentioned in the memorandum.
4. Non-convertible preference shares
Non-convertible preference shares are those in which the holder does not get the right to convert them into equity shares. As preference shareholders, they get preference in dividend payments and repayments in case of company liquidation.
5. Participating preference shares
Preference shareholders usually get a fixed rate of dividends. However, participating preference shares offer additional benefits. If the company marks extraordinary earnings, these shareholders get the opportunity to earn from extra profits, in addition to a fixed dividend, after other shareholders are paid. Plus, in case of company liquidation, they get the right to earn from the profits after the rest shareholders are paid.
6. Non-participating preference shares
As the name suggests, shareholders owning these shares do not enjoy the right to participate in extra profits and only get fixed dividends.
Common Stock Vs Preferred Stock
Here are some differences between equity shares and preference shares.
| Point of difference | Common stock | Preferred stock |
| Voting rights | Common stockholders enjoy voting rights. | Preferred stockholders do not enjoy voting rights. |
| Order of repayment in the liquidation of the company | Common stockholders get repaid after preferred stockholders. | Preferred stockholders get repaid after debtholders and before common stockholders. |
| Payment of dividends | Common stockholders get dividends after preferred stockholders get paid. | Preferred stockholders get paid dividends before common stockholders. |
| Volatility | Relatively more volatile | Relatively less volatile |
| Potential for capital appreciation | The potential for capital appreciation is relatively high. | The potential for capital appreciation is relatively less. |
Final Thoughts
Common stocks and preference shares are well-known investment avenues, and both carry their own pros and cons. After thoroughly understanding their concepts, risk and returns, and differences, you may decide what to invest in.
If you want to invest in equities and exchange-traded funds, you can consider WealthBaskets by WealthDesk, as they are the research-backed combinations of stocks and ETFs based on idea, theme or strategy and are built by SEBI-registered professionals.
FAQs
Preferred shareholders enjoy priority, over common stockholders, for receiving dividends and getting repaid in case the company goes bankrupt. In that sense, preferred stocks are less risky than common stocks.
– One of the downsides of preferred stock is
that the preferred stockholder does not have much
say in the company’s matters and decisions, as
they don’t have voting rights, even after
having partial ownership.
– Plus,
preferred shares are less likely to offer quick and
significant returns.
Investors looking for steady and regular income from stocks may benefit from preferred stocks. The company might benefit from raising funds through shares without diluting equity and control.
Investors seeking steady and regular returns and higher returns than bonds may prefer preferred stocks.
By issuing common stock, companies raise funds from the general public. Investors may earn returns as a reward for risking their money.
