When investors decide to invest in the stock market, they often encounter two primary types of stock: preferred stock and common stock.

While both represent ownership in a company, they come with distinct features that can influence an investor's decision-making process.

Ownership and Voting Rights: The Core of the Difference

The most fundamental difference between common stock and preferred stock lies in the level of ownership and the associated voting rights within the company.

Common Stock: Common shareholders are considered the "owners" of a company and typically have voting rights. These rights allow shareholders to vote on key company decisions, such as the election of board members, mergers, and acquisitions. The more common shares you own, the greater your voting power.

Preferred Stock: Preferred stockholders generally do not have voting rights. While they own a stake in the company, their ownership does not come with the same level of control over the company's governance as common stockholders. However, preferred shareholders have a higher claim on assets and earnings, which we'll explore further below.

Dividends: The Priority of Preferred Stock

One of the most significant differences between common and preferred stock is the way dividends are paid.

Common Stock: Dividends for common shareholders are not guaranteed. If a company does well and earns profits, it may decide to pay out dividends to common stockholders. However, if the company faces financial difficulties, it may choose to suspend or reduce these payments. In other words, common stockholders are last in line to receive dividends.

Shelby M.C. Davis, founder of Davis Selected Advisers: "Invest for the long haul. Don't get too greedy and don't get too scared."

Preferred Stock: Preferred shareholders have a higher claim on dividends. These dividends are often fixed and paid out regularly, regardless of the company's financial performance, as long as the company remains solvent. If the company cannot pay dividends in a given period, the missed dividends often accumulate and must be paid before any dividends are issued to common stockholders.

Priority in Liquidation: Safety for Preferred Stockholders

Another key difference between common and preferred stock relates to the order of claims in the event of a company's liquidation or bankruptcy.

Common Stock: In the unfortunate event that a company goes bankrupt, common shareholders are the last to be paid after all debts and obligations, including bondholders, creditors, and preferred shareholders. As such, common stockholders face a higher level of risk, particularly if the company's liquidation value is insufficient to cover all its liabilities.

Preferred Stock: Preferred stockholders have a higher claim on the company's assets in the event of liquidation. After debt holders are paid, preferred shareholders are next in line to receive any remaining assets. This provides a degree of protection in times of financial hardship, though they still take a backseat to debt holders.

Potential for Capital Appreciation: Common Stock Offers More Growth

For investors seeking long-term growth potential, common stock offers significant advantages over preferred stock. While preferred stock provides a reliable income stream through dividends, common stock has greater potential for capital appreciation.

Common Stock: Common stockholders benefit from the company's growth and success. If the company performs well and its stock price increases, common stockholders can sell their shares at a profit.

Preferred Stock: While preferred stock provides a fixed dividend, it generally lacks the same potential for significant capital appreciation. Preferred stock tends to be more stable, but it doesn't offer the same growth prospects as common stock, making it a less volatile but also less rewarding option for those seeking high returns.

Suitability for Different Investor Goals: Matching Strategy with Needs

When deciding between preferred and common stock, it's essential to align your investment choices with your financial objectives, risk tolerance, and time horizon.

Common Stock: Common stock is ideal for investors who are looking for growth and are willing to accept the volatility and risks that come with it. It's well-suited for long-term investors who are focused on capital appreciation and willing to ride out market fluctuations.

Preferred Stock: Preferred stock appeals to income-focused investors or those seeking stability. It's particularly attractive to retirees or others who rely on consistent income streams. With its fixed dividend structure and priority in liquidation, preferred stock provides security and income with relatively less risk, though without the same potential for growth.

The choice between preferred stock and common stock depends largely on your investment strategy and objectives. Common stock offers the potential for higher growth and greater participation in a company's success but comes with increased risk and volatility. Preferred stock, on the other hand, provides stability, consistent dividends, and priority in liquidation but sacrifices growth potential and voting rights.

By understanding the key differences between the two, investors can make more informed decisions that align with their financial goals. Whether you're seeking long-term growth or a reliable income stream, understanding the nuances of preferred and common stock will help you navigate the stock market with confidence and purpose.