Common Stock: What It Is, Different Types, vs. Preferred Stock
Summary:
Common stock represents stocks that provide ownership in a company with associated voting rights. Common stocks include voting and non-voting shares, Class A and Class B stock, convertible common stock, restricted common stock, common stock with warrants, etc. Preferred stock, on the other hand, offers fixed dividends and an upper hand in liquidation but lacks voting advantages and the potential for capital gains. Your decision of purchase depends on your income requirements and risk tolerance.
One of the most popular ways to grow your wealth and participate in the financial markets is through investing in stocks. Stocks are essentially of two types: common stock and preferred stock. Common stockholders are the owners of the company with residual claim on its assets and earnings. In contrast, even though Preferred stockholders are also considered owners of the company, they typically do not have the same voting rights or influence over company decisions as common stockholders.
In this blog, let's uncover the intricacies of common stocks vis-a-vis preferred stocks and how they can shape your financial future.
What is Common Stock?
Common stock, also referred to as "common shares" or "common equity," is indicative of a form of ownership in a corporation. When you own common stock in a company, you become a shareholder. This means you have a vested interest in the profitability, performance, and financial outcomes of the business. When trading companies issue common stocks, they essentially sell a piece of the company and give you the opportunity to participate in its success or failure. This makes common stocks subject to both capital gains and dividends as well as the risks. It is therefore important to assess your investment goals and risk tolerance if you are looking to invest in common stock.
Different Types of Common Stock
Common stocks come in various forms, each with its own set of characteristics. It is crucial to be aware of the different types to be able to make an informed decision on which stocks to buy. Let us examine at some of the most common types of common stocks:
- Voting and Non-Voting Stock: Some companies issue both voting and non-voting common stock. While voting common stocks provide the right to vote on company matters, non-voting stocks do not. Thus, if you want to invest without a say in the company management, non-voting common stocks are for you.
- Class A and Class B Stock: Companies issue different classes of voting common stocks, each with distinct voting rights and dividend preferences. Here, Class A stockholders essentially have more voting power than Class B stockholders. Class A stocks are retained by the company founders and insiders while Class B stocks distributed to the public.
- Restricted Common Stock: Restricted common stocks, as the name suggests, offer certain restrictions on when it can be sold or transferred. Company insiders are usually the owner of such stocks and the restrictions are placed to prevent rapid selling or trading of shares.
- Common Stock with Warrants: Some common stocks issued by companies come with warrants. As an owner of these warrants, you can purchase additional shares at a specific price within a defined period. This increases your exposure to the company's stock.
- Convertible Common Stock: Convertible common stocks combine features of both common stock and convertible securities. If you own these stocks, you have the option to switch your common stocks into a predetermined number of preferred shares or other securities whenever you want.
Common Stock vs. Preferred Stock
Now, let us see how common stocks compare to preferred stocks. Preferred stocks represent another type of stock or asset ownership and differ from common stocks in its characteristics, financial preferences, and rights owned.
| Characteristic | Common Stocks | Preferred Stocks |
| Voting Rights | Common stockholders typically have voting rights and can participate in numerous corporate decisions. | Preferred stockholders usually have no say in the company's governance due to lack of voting rights. |
| Dividends | Common stocks pay dividends sometimes, which are usually paid after preferred stock dividends. These are variable and not always received. | Preferred stockholders receive fixed dividends at a predetermined rate. This means their claim on the company's earnings is higher |
| Risk and Reward | Market fluctuations have a bearing on common stock dividends and share prices which provides scope for higher returns but more significant risks | Preferred stockholders’ income from dividends is hugely stable but lacks the potential for capital appreciation |
| Liquidation Preference | Common stockholders are paid off in the event of company liquidation. This means their claim on the company’s assets is residual | Preferred stockholders’ priority lies in receiving their initial investment back in case there is liquidation |
To sum up
Common stock is the most popular way to obtain ownership and voting rights in a company. However, there are numerous risks associated with them and the dividends are variable. Preferred stock, on the other hand, offers more stable dividends and a higher claim in the event of liquidation. Although, Preferred stockholders cannot vote and decide on the company’s future.
When deciding to invest, it is crucial that you thoroughly research the specific company, understand its financial health, and consider your own financial objectives and risk tolerance. Diversification of your portfolio with a mix of both types of stock will help mitigate risks and build a balanced investment strategy.
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