Common stock vs preferred stock

The stock market provides diversification opportunities within its asset classes. When you buy stocks of companies, you do not think much about the tags they come with. Investors leverage these stocks to create a stock market strategy that caters to their short-term and long-term financial goals.

Two of the most widely invested stock types are Common stocks and Preferred stocks. In this blog, you will learn about the difference between common stocks and preferred stocks and how you can use them to create an ideal and profitable portfolio. But first, a little about shares.

What are shares, and who are the shareholders?

In simple words, a share indicates a unit of ownership of a particular company. If you own the shares of a company, it implies that you, as an investor, own a percentage of the issuing company. These shares are listed on the stock exchanges through an Initial Public Offering. Investors can buy and sell them based on their current price.

If you buy the shares of a company, you become the owner of the company in the proportion of the percentage of shares purchased. From the day you buy the shares, you are a shareholder and you are entitled to receive a portion of the profit of the company. This amount is called the dividend amount, and the company declares it as per its financial performance. The shareholders can sell these shares anytime they want to another investor who would then become the shareholder.

Common Stocks and Preferred stocks: The definitions

What are Common Stocks?

Similar to every other type of share, common stocks are securities that reflect the ownership of investors in the company. This means that the investors become part-owners of the company in proportion to the shares held. The primary motive behind buying common stocks is to have the voting power they give to the investors.

Once you hold the common stocks of a company, you are entitled to elect the company’s board of directors. These voting rights help you to be a part of the company’s internal decision making and vote on various company policies

Big fund houses and financial corporations highly prefer common stocks as they want to have some control over the company they are investing in. As the company policies may be negative, holding common stocks allows these investors to safeguard their long-term interests and not let the company choose profitability overgrowth.

What are Preferred Stocks?

Preferred stocks provide investors with priority claims at the time of the company paying dividends. It means that if a company announces dividends, investors who hold preferred stocks are the first ones who are paid dividends. Only after these investors are paid, other types of stockholders can claim the dividend amount. Although the exact terms for payments for preferred shareholders can differ from one company to the other, the factors of priority claim and no voting rights are constant. Furthermore, if the company enters the liquidation process, preference shareholders are paid in full before any other type of shareholders. However, preference shares do not entitle the shareholders to have voting rights and are not involved in the internal decision-making of the company.

Common Stocks and Preferred Stocks: The Aim

Common Stocks

When investors talk about stocks, they always refer to common stocks. The returns of Common stocks tend to outperform the returns of other types of stocks over time. It is a result of the company doing well by increasing its profitability in the long term.

The main aim behind buying common stocks is voting power, which investors think is vital in the process of a company doing financially well. Common stock investors believe that a company may take negative decisions that protect their interests rather than catering to the company’s performance. Hence, they buy common stocks to elect the board of directors and have voting powers to have a say in the internal decision-making.

Preferred stocks

Preferred stocks are traded less as their availability is limited. However, investors choose preferred stocks over common stocks because of the priority claim factor that affects the investors in two ways:

• First, if the company announces a dividend, preferred stockholders are paid before every other type of stockholder.
• Secondly, if the company goes bankrupt, preferred stockholders can claim the company asset according to their ownership in the company before other types of stockholders.

The main aim behind buying the preferred stocks is to earn a steady income through claiming priority towards dividend payouts. Furthermore, preferred stocks also entitle investors to apply cumulatively for any missed dividend payments that are also paid before common stockholders.

Which one to buy between Common stock and Preferred Stock?

Both the common stock and preferred stock include unique features. While common stocks come with voting rights, preferred stocks come with the priority claim. While choosing between the two, an investor must review and analyze the financial goals for which the investment is being made. For example, suppose you are investing to get a steady income that is relatively risk-free. In that case, you can invest in preferred stocks because of the priority claim at the time of dividend payout and bankruptcy.

On the other hand, if you are investing for earning potentially high returns and have a relatively higher risk appetite, you can invest in common stocks. Furthermore, you can choose common stocks if you want to be a shareholder that has voting rights and a say in electing the board of directors.

However, the best way to look towards common stock and preferred stock is to consider an investment strategy that allocates a portion of your capital into common stocks and the remaining into preferred stocks. In this way, you can reap the benefits of both types of stocks and manage the overall risk.

How to buy Common stock and Preferred stock

The Securities and Exchange Board of India has made it mandatory for investors to have a Demat account to buy any type of shares, be it common stocks or preferred stocks. You can open a Demat account with IIFL that offers highly competitive prices and unique features in just a few steps:

1. Visit www.indiainfoline.com or the IIFL markets mobile app. Click on open a trading account Enter Basic details.
2. You will receive a one-time password (OTP) on the mobile number and a link on your registered email ID. You need to enter the OTP received
3. After verifying the OTP, you need to fill out the online Account Opening Form.
4. Your Relationship Manager will then contact you for the necessary documentation.
5. Once the documentation process is completed, and the forms are received at HO, the account will be opened within 24 hours.

Once your Demat and trading account is opened, you can buy common stocks or preferred stocks of any company you want and enjoy the benefits that come with them.

Final Words

If you are a stock market investor, understanding the difference between common stock and preferred stock is vital in making a comprehensive investment strategy and ensuring you achieve all of your financial goals. Like professional investors, you can also leverage what you have learned from common stock vs preferred stock and make your portfolio healthy. For any other financial advice, consult the financial advisors at IIFL.