Preferred Stock Vs. Voting Shares

• Common stock

  This is the type of investment that most people think of when talking about stocks. When you watch business coverage on television, the prices scrolling in the screen are, with some exceptions, common stock quotes. A share of common stock is considered equity in a company; hence the ability of a share owner to "vote their shares" for the election of corporate officers. Some common stocks pay dividends, but a dividend can be canceled at any time by the corporate board.

• Preferred stock

  Preferred stock blends some of the features of common stocks and bonds. While bonds are not the subject here, suffice it to say that a bondholder buys a company's debt. Like a bond, preferred stock owners are promised a guaranteed interest rate on their investments. The owner of a preferred share has no voting rights at corporate meetings.

• Pricing

  The price of common stock is tied to the performance of the company. Any number of things may affect common stock prices on a daily basis, from executives leaving the firm to announcements (and even rumors) about corporate policy changes or operating results. Preferred stock price is based on interest rates -- another similarity with bonds. Price tends to rise when interest rates fall and vise versa. Interest rates can be volatile, too -- but it's important for an investor to understand the external forces that affect the price of their shares.

• Rights in the event of liquidation

  Bondholders are first in line in the event of a corporate failure. They receive a share of the company's assets before any other investors. Preferred stock owners come next, followed by common stock owners. The truth is that none of the three groups can expect to get much if the company in which they've invested fails. Bondholders may get something, however, while preferred holders get a little and common stock generally becomes worthless.

• More features

  A company has the right to terminate dividend payments at any time -- for common and preferred shares. Assuming there are dividends, it is required that all preferred dividends be paid before any common dividends are paid. Another feature of many preferred shares is convertibility -- the right of the owner to trade preferred shares for a predetermined number of common shares. There is no such convertibility for a common share owner.

• Advantages from the company's view

  Companies have more control over preferred stock than common stock. A company can structure preferred shares into different "classes," each with slightly different interest rates, purchase prices, etc. Other variations include preferred stock with variable interest rates and "participating" preferred stock that pays increased dividends when the common dividend exceeds the preferred. Private companies like to issue preferred stock because they can raise funds without granting a say in corporate decisions, since preferred shares do not come with voting rights.

References & Resources

• Financialstability.gov: Decoder
• USA Today: Preferred stock can give you income and appreciation
• AllBusiness.com: Common Stock vs. Preferred Stock
• AccountingCoach.com: Stockholders' Equity