Lesson 3 - Common Stocks v Preferred Stocks

Understanding Preferred Stock

• Preferred stock is another form of company ownership, often less familiar than common stock for investors.

Key Differences Between Common and Preferred Stock

• Protection:

  • Preferred stocks provide investors with an added layer of protection during financial distress.

  • In the event of the company becoming insolvent, preferred stockholders have a prioritized claim on the company’s assets before common shareholders.

• Income Security:

  • Preferred stocks offer greater income security compared to common stocks, especially when the company is financially stable.

Dividend Payments

• Preferred stocks pay set dividends at regular intervals.

• In circumstances where the company cannot make dividend payments, the unpaid preferred dividends accrue.

  • These dividends must be paid in arrears before any dividends can be distributed to common shareholders.

Advantages and Disadvantages

• Advantages of Preferred Stocks:

  • Added protection in case of insolvency.

  • Regular and predictable dividend payments enhance income stability.

• Disadvantages of Preferred Stocks:

  • Preferred shares do not come with voting rights, limiting holders' control over company management.

  • The predictable payout structure typically results in more stable prices, which restricts opportunities for significant capital gains.

Comparison to Bonds

• Similar to bonds, preferred shares are rated for financial strength.

• However, they do not provide the same level of investment protection as bonds.