What is Common Stock (Ordinary Share)?
Common stock is a type of security that represents ownership in a corporation. When you purchase common stock, you become a shareholder of the company, which gives you the right to vote on certain corporate decisions and to receive a portion of the company’s profits in the form of dividends.
Unlike preferred stock, which typically has a fixed dividend payment and priority over common stock in the event of liquidation, common stock dividends can vary depending on the company’s profitability and are usually paid out after preferred dividends have been paid.
Common stockholders also have the potential to benefit from capital appreciation if the company’s stock price increases over time. However, they also bear the risk of losing their investment if the company’s performance deteriorates.
In case of liquidation of the concerned company, the ordinary shareholders can claim only the remaining amount after paying the amount due to the debenture holders and preference shareholders. For this reason, investing in ordinary shares is considered risky. Only for aggressive investors who are willing to take more risks to get higher returns, securities tools like ordinary shares are considered suitable.
In summary, common stock is a way for individuals to invest in a company and become part owners of it, with the potential to receive dividends and benefit from the company’s growth.
What is Preferred Stock (Preference Share)?
Preferred stock typically offers a fixed dividend payment that is paid out before any dividends are paid to common stockholders, which means that preferred stockholders receive a consistent stream of income. Preferred stockholders also have priority over common stockholders in the event of a company’s liquidation, which means that they are more likely to receive a portion of the company’s assets if it goes bankrupt.
Unlike common stock, preferred stock generally does not come with voting rights. This means that preferred stockholders do not have a say in the company’s day-to-day operations or its strategic decisions. However, in some cases, preferred stock may come with special voting rights that allow preferred stockholders to vote on certain matters, such as changes to the company’s capital structure or mergers and acquisitions.
Preferred shareholders are not allowed to attend the company’s annual general meeting unless they are discussing issues related to their rights. These shares are considered as hybrid security because they feature both ordinary shares and debentures.
Overall, preferred stock is often seen as a more stable and less risky investment than common stock, since it offers a fixed dividend payment and priority in the event of a company’s liquidation. However, preferred stock may also offer lower potential returns than common stock, since it generally does not come with the same level of growth potential.
Preferential shares can be cumulative (to be paid from the next year’s profit with dividend savings when the company is unable to pay dividends at a loss in any given year) or non-cumulative, redeemable (repayable after a certain period of time) or irredeemable (perpetual), convertible (can be converted into ordinary shares after a certain period of time) or non-convertible.
Difference Between Common Stock And Preferred Stock
Common stock and preferred stock are two types of equity investments in a company, but they differ in several key ways.
1. Dividend payments: Preferred stock typically offers a fixed dividend payment, while common stock does not guarantee any dividend payments. Common stock dividends are usually paid out of a company’s profits, which can vary from year to year, whereas preferred stock dividends are typically fixed and paid out regularly.
2. Voting rights: Common stockholders generally have the right to vote on important company decisions, such as electing board members and approving mergers or acquisitions. Preferred stockholders usually do not have voting rights, but in some cases, they may have special voting rights on certain matters.
3. Priority in the event of bankruptcy: Preferred stockholders have priority over common stockholders in the event of a company’s liquidation or bankruptcy. This means that preferred stockholders are more likely to receive their initial investment back before common stockholders receive anything.
4. Volatility: Common stock is generally considered to be more volatile than preferred stock, as its value can fluctuate based on a company’s performance, market conditions, and other factors. Preferred stock is typically more stable, as its dividend payments are fixed and its value is less sensitive to market fluctuations.
5. Redemption: Preferred stock may be redeemable, meaning the company has the option to buy back the stock from investors at a predetermined price. Common stock is typically not redeemable.
Overall, common stock is seen as a riskier but potentially more rewarding investment, while preferred stock is considered to be less risky but with lower potential returns. Investors may choose to hold a mix of both types of stock in their portfolio to balance risk and return.