6.1 Common and Preferred Stock Features
4 min read•july 18, 2024
Stocks are a fundamental part of finance, representing ownership in companies. offers potential for growth and , while provides steady income and higher priority in liquidation. Understanding these differences is crucial for investors.
Both types of stocks come with unique benefits and drawbacks. Common stock allows for greater participation in a company's success, while preferred stock offers more stability. Factors like company performance, market conditions, and investor sentiment influence stock values.
Common and Preferred Stock
Characteristics of stock types
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Rules and Rights of Common and Preferred Stock | Boundless Finance View original
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- Common stock
- Represents ownership in a company grants the holder a proportional share of the company's assets and profits
- Voting rights for shareholders allows them to participate in corporate decision-making (electing board of directors, approving mergers)
- Potential for capital appreciation and if the company performs well, leading to higher stock prices and possible dividend payouts
- Lower priority in liquidation and dividend payments common stockholders are last in line to receive assets and dividends after creditors and preferred stockholders
- Preferred stock
- Hybrid security with characteristics of both stocks and bonds combines ownership features with fixed-income attributes
- Fixed dividend payments provide a steady stream of income, similar to bond interest payments
- Higher priority in liquidation and dividend payments compared to common stock preferred stockholders have a greater claim on assets and dividends
- Generally no voting rights preferred stockholders usually do not have a say in corporate governance matters
Rights of stockholders
- Common stockholders
- Right to vote on corporate matters (electing board of directors, approving mergers) allows shareholders to influence company decisions
- Right to receive dividends, if declared by the board of directors entitles shareholders to a portion of the company's profits
- Right to share in the company's assets upon liquidation, after creditors and preferred stockholders are paid gives common stockholders a claim on remaining assets
- Preferred stockholders
- Right to receive fixed dividend payments before common stockholders ensures a consistent income stream
- Higher claim on assets in the event of liquidation compared to common stockholders provides greater security
- Potential for cumulative dividends (if stated) allows for the accumulation of unpaid dividends to be paid in the future
- Potential for participating dividends (if stated) grants the right to receive additional dividends beyond the fixed rate
- Potential for to common stock (if convertible preferred stock) offers the option to convert preferred shares into common shares at a predetermined ratio
Benefits and drawbacks of stocks
- Benefits of investing in common stock
- Potential for capital appreciation as the company grows and becomes more profitable stock price may increase, leading to higher returns
- Opportunity to participate in the company's success through dividend payments shareholders can benefit from the company's profitability
- Voting rights allow shareholders to have a say in corporate governance gives investors a voice in major decisions
- Drawbacks of investing in common stock
- Higher risk compared to preferred stock and bonds stock prices are more volatile and sensitive to market fluctuations
- No guaranteed dividend payments dividends are at the discretion of the board of directors and may be reduced or eliminated
- Lower priority in liquidation and dividend payments common stockholders are last in line to receive assets and dividends
- Benefits of investing in preferred stock
- Consistent, fixed dividend payments provide a reliable income stream
- Lower risk compared to common stock preferred stock prices are generally less volatile
- Higher priority in liquidation and dividend payments offers greater protection for investors
- Drawbacks of investing in preferred stock
- Limited potential for capital appreciation preferred stock prices are less likely to increase significantly
- Generally no voting rights preferred stockholders have limited influence over corporate decisions
- Callable feature may limit the upside potential if the company decides to redeem the shares the issuer can repurchase the stock at a predetermined price
Factors influencing stock value
- Factors influencing common stock value
- Company's financial performance (revenue growth, profitability) strong financials attract investors and drive up stock prices
- Industry trends and market conditions favorable industry outlook and market sentiment can boost stock values
- Investor sentiment and expectations positive investor perception and confidence in the company's future prospects can increase demand for the stock
- Dividend policy and growth prospects consistent dividend payouts and expected future growth make the stock more attractive
- Factors influencing preferred stock value
- Credit rating of the issuing company higher credit ratings indicate lower risk and make the preferred stock more desirable
- Prevailing interest rates lower interest rates make preferred stocks more appealing compared to fixed-income alternatives
- Yield spread between preferred stock and other fixed-income securities a higher yield spread can attract investors seeking better returns
- Liquidity of the preferred stock higher trading volume and ease of buying and selling can positively impact the stock's value
- Presence of special features (callability, convertibility) these features can affect the stock's value and investor demand
Key Terms to Review (13)
Bull market: A bull market refers to a period in which the prices of securities are rising or are expected to rise. This optimistic phase often encourages investors to buy stocks, anticipating further price increases, which can lead to sustained growth in the stock market. The characteristics of a bull market can be linked to increased investor confidence, economic growth, and favorable market conditions that favor buying rather than selling.
Common stock: Common stock represents ownership in a corporation and comes with voting rights, allowing shareholders to influence company decisions. Investors holding common stock may receive dividends, which are a share of the company’s profits, but these payments are not guaranteed. This type of equity is often seen as more volatile than preferred stock but offers potential for higher returns through capital appreciation and participation in the company's growth.
Convertibility: Convertibility refers to the feature of certain financial instruments that allows holders to exchange them for another form of security, typically from a preferred stock to common stock. This capability can enhance the appeal of preferred shares by offering potential for capital appreciation, aligning the interests of shareholders and enabling investors to take advantage of changing market conditions.
Dividend payment: A dividend payment is a distribution of a portion of a company's earnings to its shareholders, typically in the form of cash or additional shares. This payment represents a way for companies to return profits to their investors, often reflecting the company's profitability and financial health. Dividends can be regular or special, and their frequency can vary, influencing investor perceptions and the attractiveness of holding a company's stock.
Dividend yield: Dividend yield is a financial ratio that shows how much a company pays in dividends each year relative to its stock price. It is expressed as a percentage and helps investors assess the income generated from owning a stock compared to its market value. This metric is important for evaluating the attractiveness of both common and preferred stocks, guiding investment decisions based on expected returns.
Dividends: Dividends are payments made by a corporation to its shareholders, typically in the form of cash or additional shares, representing a portion of the company's earnings. These payments serve as a way to distribute profits back to investors and can be a key factor in attracting and retaining shareholders, influencing investment decisions and company valuation.
Fixed dividends: Fixed dividends are a predetermined payment made to preferred stockholders, typically expressed as a percentage of the par value of the stock. These dividends are paid out regularly, often on a quarterly basis, and are prioritized over common stock dividends, meaning preferred shareholders receive their fixed payments before any dividends can be distributed to common shareholders. This fixed nature provides a level of income stability for investors in preferred stocks, making it an attractive feature for those seeking reliable returns.
Nasdaq: The NASDAQ is an electronic stock exchange based in the United States that allows investors to buy and sell shares of publicly traded companies. It is known for having a high concentration of technology and growth-oriented firms, making it a key player in the global financial markets and providing a platform for both common and preferred stock transactions.
NYSE: The NYSE, or New York Stock Exchange, is the largest and most prestigious stock exchange in the world, located in New York City. It serves as a marketplace where shares of publicly traded companies are bought and sold, facilitating capital raising and investment opportunities. The NYSE plays a crucial role in the financial markets by providing liquidity and price discovery for various securities, including common and preferred stocks.
Preferred stock: Preferred stock is a type of equity security that gives shareholders a higher claim on assets and earnings than common stockholders. It typically pays fixed dividends and has priority over common stock in the event of liquidation, making it an attractive option for investors seeking steady income with less risk compared to common shares.
Reverse stock split: A reverse stock split is a corporate action where a company reduces the number of its outstanding shares while increasing the share price proportionately. This means that shareholders receive fewer shares but at a higher price, which can help the company meet minimum share price requirements for listing on stock exchanges and can improve the perception of the stock's value.
Stock dividend: A stock dividend is a payment made by a corporation to its shareholders in the form of additional shares, rather than cash. This method of rewarding shareholders is often used when a company wants to retain cash for growth but still wants to provide value to its investors. Stock dividends can affect the overall number of shares outstanding and can influence a company's stock price, as well as how investors perceive a company’s financial health and dividend policy.
Voting Rights: Voting rights refer to the privileges that allow shareholders of a corporation to participate in decision-making processes, typically through voting on key issues such as the election of the board of directors or major corporate actions. These rights are most commonly associated with common stock, where shareholders have the power to influence company policies, while preferred stockholders usually do not possess these voting privileges, highlighting a crucial distinction in equity ownership.