Difference Between Common Stock and Preferred Stock

Common stock and preferred stock are the two main types of shares that companies issue to raise capital from the market. Common stock, also known as equity shares in India, represents true ownership and gives you the right to vote on important company decisions. Preferred stock, or preference shares, functions like a hybrid between a stock and a bond because it offers fixed dividends but usually no voting rights. The main difference lies in how you get paid; preferred shareholders have a higher claim on a company's assets and earnings. If a company faces financial trouble or closes down, preferred shareholders are paid before common stockholders. However, common stockholders have the potential for much higher long-term growth if the company becomes very successful.

What is Common Stock?

In the Indian stock market, what most people buy on the National Stock Exchange (NSE) or Bombay Stock Exchange (BSE) is common stock. When you own these shares, you are a partial owner of the business. You share in the profits when the company does well, and you also take the risk if it fails.

The most important feature of common stock is voting rights. Every year, companies hold an Annual General Meeting (AGM) where shareholders vote to elect directors or approve major changes. Your voting power is usually proportional to the number of shares you hold. While common stock offers the highest potential for capital appreciation (the share price going up), the dividends are not fixed and are paid only after all other obligations are met.

What is Preferred Stock?

Preferred stock is a unique financial instrument that provides specific preferences over common stock. It is often favored by investors who want a steady income rather than aggressive growth. In India, companies like public sector units or large private corporations may issue preference shares to raise funds without diluting the voting control of the founders.

Preferred shareholders receive a fixed dividend rate, which is decided at the time of issuance. This dividend must be paid before any dividend is given to common stockholders. If the company is liquidated (closed down), preferred shareholders are second in line to get their money back, right after the creditors and bondholders but before the common shareholders.

Key Differences Between Common and Preferred Stock

Understanding these differences helps you decide which type of security fits your investment goals.

Feature	Common Stock (Equity Shares)	Preferred Stock (Preference Shares)
Dividends	Variable and not guaranteed.	Fixed and prioritized.
Voting Rights	Full voting rights in most cases.	Generally no voting rights.
Risk Level	High (highest risk among all).	Moderate (lower than common stock).
Growth Potential	Unlimited upside as the company grows.	Limited to the fixed dividend and par value.
Priority in Liquidation	Last in line (residual claimants).	Priority over common stockholders.
Nature of Instrument	Pure equity (ownership).	Hybrid (features of both debt and equity).

Read more: Equity Shares vs Preference Shares

Types of Preferred Stock in India

Preferred stock is not all the same. According to the Companies Act 2013, there are several variations available in India:

1. Cumulative Preference Shares: If a company skips a dividend payment in a bad year, the amount is not lost. It accumulates and must be paid in full in future years before any common stockholder gets a rupee.
2. Non-Cumulative Preference Shares: If the company skips a dividend, you lose it for that year. You cannot claim it later.
3. Convertible Preference Shares: These are very popular. They give you the option to change your preferred shares into a fixed number of common shares after a certain period, allowing you to benefit from future growth.
4. Participating Preference Shares: These allow you to receive your fixed dividend plus an extra share of the profits if the company performs exceptionally well.
5. Redeemable Preference Shares: These have a fixed maturity date. The company agrees to buy back the shares and return your capital after a specific number of years.

Why Do Companies Issue Both?

You might wonder why a company wouldn't just stick to one type. The answer lies in balance:

• Issuing Common Stock allows a company to get permanent capital that it never has to pay back. However, it means the founders have to share their voting power with more people.
• Issuing Preferred Stock allows the company to raise money without giving away control. It is often cheaper than taking a bank loan because the dividend payment is not a legal obligation if there are no profits.

Which One Should You Choose?

The choice depends on what kind of investor you are.

• Choose Common Stock if: You are young and looking for long-term wealth. You want to benefit from the rising price of the stock over 10 or 20 years and don't mind the daily price swings.
• Choose Preferred Stock if: You are looking for regular, stable income similar to a fixed deposit but with slightly higher returns. It is often preferred by retired individuals or large institutions like insurance companies that need predictable cash flow.

The Role of SEBI and Stock Exchanges

In India, the Securities and Exchange Board of India (SEBI) ensures that the rights of both types of shareholders are protected. Listed companies must clearly mention the class of shares they are issuing in their prospectus during an IPO. You can find the details of a company's share capital, including its preference shares, in the Investor Relations section of their website or on the NSE and BSE portals.

Conclusion

Common stock and preferred stock both offer unique ways to participate in a company's success. Common stock is about growth and control, making it the engine of a long-term portfolio. Preferred stock is about safety and income, acting as a stabilizer. By understanding the priority of payments and the power of voting, you can better navigate the stock market and build a portfolio that matches your appetite for risk and your need for returns.