A company issues its share to raise money from the public and to take the business forward. Buying stocks of a company gives ownership rights to shareholders depending on how many stocks they own. But not all shareholders get such ownership rights as there are different types of shares that a company can issue.
Here we will discuss preferred shares vs common shares.
What are common stocks?
Common stocks are the shares that investors refer to when they are talking about buying stocks of a company. The shares that are regularly traded in the stock markets every day are common stocks. There may be chances that a company issues only common stocks and no other type of stocks (e.g. preference stocks). Owning shares of a company gives investors the rights to the profits of the company in the form of dividends. However, a company doesn’t need to pay dividends to its investors. There might be rare cases where companies do not give out dividends at all to its shareholders.
Even if the company does not pay dividends, stockholders have a chance of earning high returns over an extended period. Stock markets have the potential for long term wealth creation. The risk-reward ratio is high for common stocks. This means that the risk level is as high as the return potential.
Common stock investors also get voting rights depending on how many stocks they own in proportion to the total number of shares that a company has issued. The voting rights enables shareholders to elect members of the board of directors.
Common stockholders are last in line when the company is going in for liquidation. Creditors to the company are paid first. Preference shareholders are given priority ahead of common stockholders and this is an important difference between common vs preferred stock. When an investor buys stocks of a company, they become part owners of the company, in proportion to the shares they hold. Hence they are last in line, after the creditors.
What are preference stocks?
Preference stocks do not carry any voting rights, and this is one of the main differences between common stock and preferred stock. They do carry ownership rights like common stock. The price of the preferred stock is decided by the company’s performance and market forces. These are also issued by the company to raise funds.
Preference shares come with a maturity period. When a company is issuing preference shares, it specifies the dividend rate, maturity and the dividend payment date.
In preferred stocks, investors get regular dividends. This is again a crucial difference between common stock and preferred stock. In common stocks, dividends are not fixed and do not come in regular intervals. Preferred stock has a higher claim than common stocks in case the company goes in for liquidation. Not just liquidation, preference stockholders get preference when it comes to dividends as well. A company has to pay dividends to preference shareholders first before dividends are paid to common stockholders.
Types of Preference Shares
Cumulative Preference Share: In cumulative preference shares, the issuing company can pay dividends to such shareholders in arrears. This means that if the company does not have the financial status to give out dividends, then it can pay cumulative dividends in the next year. An important point to note is that till dividend is paid to preference shareholders, they cannot be paid to common shareholders.
Non-cumulative preference shares: Shareholders of these shares can receive dividends only from one year’s profit. Hence it is non-cumulative. Such stocks do not issue dividends that are unpaid to its shareholders. Therefore, such stockholders cannot claim unpaid dividends in the future as well.
Redeemable Preference Shares: Redeemable preference shares are those shares where the company can repurchase the shares for its use from its shareholders. This can be done either at a fixed date or by giving prior notice.
Irredeemable Preference Shares: Irredeemable preference shares are shares that can be redeemed by the company only when it is going for liquidation or at the time of winding up operations.
Participating Preference Shares: In participating preference shares, the issuing company gives out increased dividends along with the preference share dividend, at a fixed rate. Shareholders of these shares also have rights on the company’s surplus assets at the time of liquidation.
Non Participating Preference Shares: Non-participating preference shares are those shares where the shareholders are eligible to receive a dividend at a fixed rate only. They do not have the rights to the surplus profit. This profit is distributed among common shareholders.
Convertible Preference Shares: In convertible preference shares, shareholders are allowed to convert their preference shares into equity shares
Also read: Detailed of Types of Preference Shares in India
Non-convertible preference shares: In non-convertible preference shares, shareholders do not have any such rights.
Preference shares with a callable option: Preference shares with a callable option are those shares where the company can buy back the stocks or has the rights to call in the stocks at a predetermined price and date. The call premium, call price and the date after which the shares will be eligible to be called are mentioned in the prospectus.
Adjustable-Rate Preference Shares: In adjustable rate preference shares, the dividend rate is influenced by the interest rates prevailing in the market; which means that the dividend rate is not fixed.
|Common Stock vs Preferred Stock|
|Particulars||Common Stock||Preferred Stock|
|Ownership Rights||Carries ownership rights||Carries ownership rights|
|Voting RIghts||Carries voting rights||Does not carry voting rights|
|Liquidation of Company||Paid last in line in case of liquidation of the company||Given preference over common stocks|
|Payment of dividends||Dividends are not fixed or mandatory||Dividends are mandatory and are more or less fixed. Should be paid before dividends are paid to holders of common stocks.|