What is the Difference Between Preferred Stock and Common Stock?

There are a number of differences – and advantages and disadvantages – to owning preferred stock over common stock shares.

A common stock is a claim to partial ownership or a share of the company's business. Common stockholders exercise partial control of the corporation by voting to elect the board of directors and voting on corporate policy. However, common stockholders are lower priority when it comes to the structure of ownership and actual rights to the company's assets. In contrast, preferred stockholders, unlike common stockholders, do not, as a rule, hold any type of voting rights regarding corporate policy or decisions of the board.

If a company is liquidated, the claims of preferred stockholders are given, in accord with the term, preference over the claims of common stockholders (hence, the name  "preferred"). The payout to common stockholders comes only after other debt-holders, bondholders and preferred shareholders have already taken their piece of the company’s assets. Common stockholders receive a portion of the assets only if and when all other claims are fully satisfied. That's why common stockholders are often referred to as "residual" owners of a company.

Other examples in which preferred shares hold a higher place in the investor pecking order include dividend payments. Common shareholders have no guarantees to dividends, but preferred stockholders generally do. They typically have a right to receive fixed dividend payments, even when a company determines there are insufficient revenues to merit declaring a dividend payment for the common shares. So, in relation to sharing in a portion of the company’s income through the payment of dividends, preferred shareholders are in a significantly better position than common shareholders. Most preferred stocks are also cumulative, which means that if the company fails to make a regularly scheduled fixed dividend payment to preferred shareholders, it subsequently must make up the payment before paying out dividends of any other kind.

Preferred stocks offer an advantage of less volatility than common stocks, but that means they do not see the large gains that common stockholders can see. Events and announcements that send common stock price soaring may have a comparatively little effect on the preferred-stock value. The preferred dividends generally stay fixed, too, meaning they won't decline. But they won't benefit from a bump-up either.

For this reason, growth investors may not find preferred stock very appealing. However, income-oriented investors are generally attracted to the stronger fixed-income position offered by preferred stock.

The most preferred stock is callable. With this type of stock, the company has the right to redeem or repurchase the shares, usually after a specified date. So, unlike common stockholders, preferred shareholders may have to surrender their investments earlier than they want to, and in a way, this prevents them from realizing some of the income they expected to gain from holding the stock.