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Milan Vaishnav
Milan Vaishnav, Financial Advisor
Category: Finance
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Experience:  Technical Analyst in Financial Markets -- Experience of more than 10 years in consulting
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What is the difference between Preferred Stock and Common Stock

Resolved Question:

What is the difference between Preferred Stock and Common Stock? Why might a company prefer the use of Preferred Stock over Common for long term financing?


300 words or more in detail
Submitted: 7 years ago.
Category: Finance
Expert:  Milan Vaishnav replied 7 years ago.
Dear Friend,

Here you go...Total Word Count 533 (excluding the references)

Preferred stock, also called preferred shares or preference shares, is typically a 'higher ranking' stock than common stock, and its terms are negotiated between the corporation and the investor.

Common stock is a form of corporate equity ownership, a type of security. It is called "common" to distinguish it from preferred stock. In the event of bankruptcy, common stock investors receive their funds after preferred stock holders, bondholders, creditors, etc. On the other hand, common shares on average perform better than preferred shares or bonds over time.

Differences:

There are significant differences between common and preferred stock. Generally, you will want to issue common stock to founders and employees through the employee stock option program and offer preferred stock to investors.

First, preferred stockholders have a greater claim to a company's assets and earnings. This is true during the good times when the company has excess cash and decides to distribute money in the form of dividends to its investors. In these instances when distributions are made, preferred stockholders must be paid before common stockholders. However, this claim is most important during times of insolvency when common stockholders are last in line for the company's assets.

This means that when the company must liquidate and pay all creditors and bondholders, common stockholders will not receive any money until after the preferred shareholders are paid out.

Second, the dividends of preferred stocks are different from and generally greater than those of common stock. When you buy a preferred stock, you will have an idea of when to expect a dividend because they are paid at regular intervals. This is not necessarily the case for common stock, as the company's board of directors will decide whether or not to pay out a dividend. Because of this characteristic, preferred stock typically don't fluctuate as often as a company's common stock and can sometimes be classified as a fixed-income security. Adding to this fixed-income personality is the fact that the dividends are typically guaranteed, meaning that if the company does miss one, it will be required to pay it before any future dividends are paid on either stock.

The holders of common stock can reap two main benefits from the issuing company: capital appreciation and dividends. Capital appreciation occurs when a stock's value increases over the amount initially paid for it. The stockholder makes a profit when he or she sells the stock at its current market value after capital appreciation.

Preferred stock doesn't offer the same potential for profit as common stock, but it's a more stable investment vehicle because it guarantees a regular dividend that isn't directly tied to the market like the price of common stock. This type of stock guarantees dividends, which common stock does not. The price of preferred stock is tied to interest rate levels, and tends to go down if interest rates go up and to increase if interest rates fall.

Like common stock, preferred stock represents ownership in a company. However, owners of preferred stock do not get voting rights in the business.

To sum up: a good way to think of a preferred stock is as a security with characteristics somewhere in-between a bond and a common stock.

References:
http://en.wikipedia.org/wiki/Preferred_stock
http://en.wikipedia.org/wiki/Common_stock
http://www.allbusiness.com/business-planning/business-structures-incorporation-stock/792-1.html
http://www.investopedia.com/ask/answers/182.asp
http://www.allbusiness.com/business-planning/business-structures-corporations-stock/3779142-1.html

I hope the above helps…
Regards,
Milan Vaishnav, Financial Advisor
Category: Finance
Satisfied Customers: 972
Experience: Technical Analyst in Financial Markets -- Experience of more than 10 years in consulting
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