Preferred Stock vs. Common Stock for Investors

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Preferred Stock vs. Common Stock for Investors

Securities play an essential role in the structure of the market economy, as they are an analog of money in the form of a document. Possession of them gives the right to receive a certain amount of funds or certifies property ownership. One type of security is stocks, which provide the right to receive part of the profit from the activities of the joint-stock company. There are different types of stocks, and owning each has its advantages and disadvantages.

A joint-stock company can issue common and preferred stocks. Common ones give the right to vote at the general meeting of shareholders. As a rule, the price of common stock is formed from the future income that its owner can receive. They can usually get their share of profits only after paying dividends on preferred shares. Moreover, one can pay dividends on common stocks only after payment of taxes, interest on bank loans, replenishment of reserve funds, and other expenses (Petty, et al., 2015). Therefore, one of the disadvantages of common stock over preferred ones is that the payment of dividends on common stock is not guaranteed immediately. Unlike preferred stocks, it depends on the results of commercial activity and the amount of profit received.

Preferred stocks have the properties of both stocks and bonds, and their owners have the right to a part of the corporations property. Unlike ordinary stocks, the owners of preferred ones receive a fixed income, the amount of which is determined immediately after their issue. Settlements with preferred stock owners are carried out in the first place before settlements with owners of ordinary ones. In addition, preferred stocks, as a rule, are perpetual securities, although in exceptional cases, they may have an expiration date. The companys founders can extend the preferred stock owners rights and allow them to exchange for ordinary stocks if necessary (Petty, et al., 2015). This possibility increases the investment attractiveness of the asset, as the expansion of rights reduces the risk. The owners of preferred stocks have an extended list of rights and receive a fixed income.

The rights conferred by ownership of preferred and common stocks are a determining factor in defining their value and investment risk. Therefore, the issuer can buy back the issued preferred stocks from the investor at any time. They can be exchanged for an equivalent number of common stocks or cash. In addition, the investor immediately receives the invested capital, which reduces the level of risk to a minimum. Their sensitivity to risk depends on what rights are granted to one or another class of preferred stocks (Petty, et al., 2015). The issuer can arrange the rights of the owners of preferred stocks in such a way as to attract investors on the most favorable terms. In turn, investors need to examine the company whose securities they plan to purchase.

Having studied the features of common and preferred stocks, it is clear that the latter are more attractive for investment and involve a lower level of risk for investors. For investors, the wide range of rights preferred stocks provide is proportional to the opportunities to satisfy their yield requirements. Moreover, payouts on preferred stocks are fixed, so investors, in this way, insure themselves against the risk of losses. In addition, preferred stock is convertible, meaning it can be exchanged for common stock or cash at any time. This feature protects investors from jumps in the market when the level of interest changes and, as a result, minimizes risk.

Reference

Petty, J. W., Titman, S., Keown, A. J., Martin, P., Martin, J. D., & Burrow, M. (2015). Financial management: Principles and applications. Pearson Higher Education AU.

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