TradingKey - Stocks can be categorized into various types based on their characteristics and the rights associated with ownership. The two primary types are common and preferred stocks, each offering distinct features and advantages to investors. Understanding their characteristics and differences is essential for investors and anyone interested in finance.
What is Common Stock?
Common stock is a basic equity security typically issued during an initial public offering (IPO) that represents a claim on a company’s assets and earnings. When investors hold common stock, they have voting rights and can share in the company’s profits through dividends and capital appreciation.
However, in the event of a company's liquidation, common stockholders rank last in priority. This means they will only receive a payout after all creditors, bondholders, and preferred shareholders are compensated.
What Are the Three Core Advantages and Risk Pitfalls of Common Stock?
Equity Control
Common stock serves as the core equity instrument for companies, granting shareholders substantial voting rights—one vote per share—allowing direct participation in significant decisions like board elections, mergers and acquisitions, and equity incentive plans. This "ownership premium" positions investors as financial backers and as participants in corporate governance, particularly valued by long-term value investors.
Floating Dividends
Dividends on common stocks depend on the company’s financial health and the decisions of its board of directors. Profitable companies may choose to pay dividends, but in cases of poor performance or when profits are reinvested, dividends may not be distributed.
High liquidity
Common stocks, especially those of large publicly traded companies, are highly liquid. They can be readily traded on stock exchanges, providing investors with the ability to swiftly enter or exit their positions.
Risk and Return Potential
Common stocks carry higher risks but offer significant return potential. Their value is influenced by market trends, economic conditions, company performance, and industry competition. While a successful company can drive substantial stock price increases, poor performance or unfavorable market conditions can lead to sharp declines and heavy losses for investors.
What is Preferred Stock?
Preferred stock is a special equity instrument that combines characteristics of both stocks and bonds. Investors often view it as a stable investment tool, enjoying priority in dividend distributions, with dividend rates typically fixed. In the case of company liquidation, preferred shareholders have a priority claim on the company's assets, which is senior to that of common shareholders. However, they generally lack voting rights or have limited voting rights. Preferred stock prices are relatively stable, making them ideal for investors seeking predictable returns without a desire to influence company decisions.
What Are the Features of Preferred Stock?
Priority of Dividends
As a "hybrid" financial instrument, the priority of dividends constitutes the core investment value of preferred stock. Dividends are distributed strictly before common stock, with most having fixed rates (e.g., 4%-8% of par value), creating predictable cash flows similar to "bonds."
For example, JPMorgan Chase (NYSE: JPM) issued 6.5% dividend-yield preferred stock in Q1 2025. With expectations of Federal Reserve interest rate cuts, its dividend spread increased from 1.8% in 2024 to 2.5%. In contrast, Apple (NASDAQ: AAPL) has seen increased uncertainty regarding its common stock dividends due to supply chain disruptions, with the probability of paying dividends in Q2 2025 dropping to 60%.
This fixed payment model provides investors with predictable cash flow akin to bond interest payments. Therefore, for risk-averse investors seeking stable income streams, preferred stock is an attractive option.
Limited Voting Rights: Priority of Returns and Governance Power Transfer
Preferred shareholders usually do not have voting rights in regular company matters. Voting rights are typically granted only in exceptional cases or under specific clauses.
Redemption and Repurchaseability
Many preferred stocks come with a redemption feature, enabling the issuing company to buy back shares at a specified price after a certain timeframe. While this provides flexibility for the company, it may lead to early termination of the investment for shareholders.
Risk-Return Characteristics: Downside Protection and Upside Limitation
Preferred stocks are less risky than common stocks due to their priority in dividends and liquidation claims. However, their return potential is lower, as price appreciation is limited compared to common stocks. Their value primarily depends on fixed dividends and redemption prices.
Convertible: The Value of Optionality
Some preferred stocks come with embedded conversion rights that create a "dual-path income channel" between stocks and bonds. These can be converted into common shares under specific conditions or within certain time frames, offering investors the opportunity to convert for potentially higher returns if the company's share price rises.
What Are the Main Classifications of Preferred Stock?
The diversity of preferred stock arises from the flexibility in its contractual terms. Based on core rights characteristics, it can be classified into several types:
- By Dividend Accumulation
- Cumulative Preferred Stocks
Unpaid dividends accumulate during periods of poor performance and must be paid before dividends to common shareholders.
- Non-Cumulative Preferred Stocks
Dividends not paid in a given year are forfeited, with no right to recover unpaid amounts. For example, Meta (NASDAQ: META) issued 5.5% non-cumulative preferred stock in 2024, which stipulates that dividends may not be paid in loss-making years.
- By Right to Participate in Residual Profits
- Participating Preferred Stocks
Shareholders receive a fixed dividend and may also participate in surplus profit distribution alongside common shareholders. In 2025, Goldman Sachs (NYSE: GS) issued certain participating preferred shares that entitle holders to only 50% of the dividends paid on common stock.
- Non-Participating Preferred Stocks
Shareholders receive only the fixed dividend rate, regardless of additional company profits. A typical example is the 4.25% non-participating preferred stock issued by Apple (NASDAQ: AAPL) in 2024, which explicitly states that it "does not participate in the distribution of remaining funds from the buyback program."
- By Convertibility into Common Stocks
- Convertible Preferred Stocks
Option value:Shareholders can convert their preferred shares into common shares under predefined terms.
- Non-Convertible Preferred Stocks
Pure debt value:These shares cannot be converted into common stock, offering only fixed dividends and priority rights.
- By Redeemability
- Redeemable Preferred Stocks
The issuing company can redeem shares at a specified time and price, providing flexibility in capital structure management.
- Non-Redeemable Preferred Stocks
These shares cannot be redeemed by the company, except in cases such as liquidation, allowing shareholders to hold them indefinitely.
- By Dividend Rate Pricing
Do You Know the Core Differences Between Common and Preferred Stock?
In summary, both common stocks and preferred stocks have unique characteristics and serve different purposes in the financial market. When deciding between the two, investors should carefully evaluate their risk tolerance, investment objectives, and return expectations.
