Common Stock vs Preferred Stock: The Differences

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Common Stock vs Preferred Stock:
The Differences

In order to effectively invest your money into stocks of any kind, you must know all of your stock options so that you can efficiently earn money. Because stocks are simply small shares of a company, the more stocks you purchase to more you own of a certain company. For example, if you purchase 100,000 stocks in AutoZone, an automotive store, you would have more say in what takes place in the company that someone who only purchases 1,000 shares of AutoZone's stock. There are two main types of stock in which, you, the investor should become familiar with so that you can properly purchase the stock that is right for you and your monetary situation.

Common Stock

Basically stated, a common stock is, well, common! When you hear people talking about stocks in general, it is these types of stocks in which they are referring. It is simply a piece of paper that represents some degree of ownership of a corporation as well as some form of profit from that particular company. Interestingly enough, investors in common stocks receive one vote per stock owned to elect board members, the people who oversee major decisions made for the company as a whole, for a particular company. In the long-term, this type of stock means capital growth for the investor, however, if the company is forced into bankruptcy, the investor will not get paid what they are owed until creditors, bondholders, and preferred stockholders receive their payments.

Preferred Stock

In general, preferred stock is stock that is owned by preferred stockholders in which all of the company's earnings and assets go directly to the preferred stockholders first. Because preferred stockholders are paid before common stockholders, preferred stockholders choose to give up their right to vote in the election of board members. Therefore, preferred stockholders have no right in the selection process of the company. Preferred stockholders purchase stock in a certain company for monetary gain only in which their main goal in investment is earning a return on investment. However, there are four variations on preferred stock investments.

Voting: Preferred stock members can opt for the right to vote in a company in which they own stock. By doing this, they ensure the power to make sure that they receive all monies owed to them because they are able to bribe people into places of management. For example, Bob is a preferred stockholder who wants to ensure that his profits are paid to him no matter what happens to the company. Bob tells Tom, a man up for board election, that he will make sure Tom wins the election as long as Tom agrees to pay Bob his profits, whether the company goes into bankruptcy or not.

Adjustable Rates: Preferred stockholders receive an agreed upon profit based on stipulations provided by the company.

Convertible Stock: Preferred stockholders have the right to convert their preferred stock into common stock, allowing the investor to lock in their profit while they potentially profit from a rise in common stock. Basically, preferred stockholders are protected no matter what types of investment decisions they make.

Participating Stock: With this type of stock, preferred stockholders not only receive a set profit, but they are eligible for a certain percentage of the company's earned profit over a set period of time.

Therefore, it may seem that a preferred stockholder position is the way to go, however, with increased power comes more headaches. If you are a beginning investor, it is better to work on common stocks for a number of years before trying to get involved with preferred stocks.

Because common stocks and preferred stocks are so different, companies are not allowed to customize either type of the stocks. The reason for this is that some companies may be corrupt and want the voting power to remain with certain investors. Companies are held under law to make sure that the voting power remains fair among both common stockholders and preferred stockholders.

It is your money and your choice, however, it is suggested that you become educated when playing with the stock market. It is important to know precisely what stocks are as well as the main characteristics of a common stock as well as a preferred stock. As with any investment, the ultimate goal is to gain a profit and this can only be done with stocks if you thoroughly understand them.