Common vs preferred stock: voting, dividends and priority

Most people who buy stocks buy common stock. Companies can also issue preferred stock, which sits between bonds and common shares. Preferred shareholders usually receive a set dividend and stand ahead of common shareholders in line for payments, but they typically give up voting rights and most of the upside if the company does very well. Understanding the two helps you read a company's capital structure and avoid mixing up securities that carry the same ticker root.

Common stock

Common stock is what the term "stock" normally means (see what is a stock).

• Voting. Holders typically get one vote per share on directors and major proposals, although companies with multiple share classes can give some holders more votes (see dual-class shares).
• Dividends. The board decides whether to pay a dividend and how much. It can raise, cut or suspend it at any time.
• Upside. Common shareholders benefit most when the company grows, because they are the residual owners. There is no cap on how high the price can go.
• Priority. They are last in line. In a liquidation, creditors are paid first, then preferred shareholders, then common shareholders receive whatever remains.

Preferred stock

Preferred stock is a separate class of equity with terms set when it is issued. The terms are in the company's charter or a certificate of designation, so the details differ from one issue to another.

• Dividends. Preferred shares usually carry a stated dividend, often expressed as a percentage of a par (or stated) value. The board still has to declare the dividend, but no common dividend can be paid unless the preferred dividend is paid first.
• Priority. Preferred sits above common but below debt in the order of claims.
• Voting. Preferred holders usually have no vote, or only limited votes, for example if dividends have been missed.
• Limited upside. The price of a plain preferred share tends to move with interest rates and the company's credit quality, not with the company's earnings growth, so it behaves more like a bond.

Features of preferred stock to check

Example (illustrative numbers)

A company issues preferred shares with a $25 par value and a 6% stated dividend. Each share pays:

$25 x 6% = $1.50 per year

If the shares trade at $25, the dividend yield is 6%. If market interest rates rise and investors want a higher return, the price of the preferred may fall to $22. The $1.50 dividend is unchanged, so the yield is now about 6.8% ($1.50 / $22). The relationship is the same as for bonds (see why bond prices fall when yields rise).

Now suppose the company has a bad year and cannot pay all of its dividends. If the preferred is cumulative, the unpaid $1.50 per share is owed and must be cleared before common holders get any dividend. If it is non-cumulative, the missed payment may simply be lost. Meanwhile, if the company later thrives and its common stock doubles, the preferred holder's price will not necessarily rise with it.

Order of claims in a bankruptcy

In general, the order is:

1. Secured creditors and lenders
2. Unsecured creditors, including bondholders
3. Preferred shareholders
4. Common shareholders

Preferred ranks higher than common but lower than all debt. In a failure, preferred holders may receive only part of their money back, and common holders often receive nothing.

Preferred vs bonds

Preferred shares pay dividends, not interest. A missed preferred dividend is not a default in the way a missed bond payment is, so the legal protection is weaker (see how bonds work). For the issuing company, interest on debt is generally tax-deductible, while preferred dividends are not, which is one reason companies use each differently.

Common mistakes and limits

• Assuming preferred is safe. It is higher in the pecking order than common stock but still subordinate to debt, and prices can drop sharply in a credit scare.
• Assuming the dividend is guaranteed. The company may be allowed to skip a preferred dividend, especially a non-cumulative one.
• Ignoring the call feature. A callable preferred can be taken back at a set price, so a high yield may not last.
• Mixing up securities. Preferred shares usually trade under a separate ticker, often with a letter suffix, and have different prices and rights from the common stock.
• Expecting equity-like growth. For most preferred shares, upside is limited.

Where to see it on StocksXray

Each stock page shows the dividends and splits history and a red-flag check for dividends above free cash flow. If a company has preferred stock outstanding, those payments rank ahead of common dividends, so the SEC filings linked on the stock page, such as those for Microsoft, are where to look for the terms.

Key takeaways

• Common stock has voting rights, a variable dividend, unlimited upside and the lowest priority.
• Preferred stock usually has a stated dividend, priority over common, little or no vote and limited upside.
• Both rank below all debt in a bankruptcy.
• Cumulative, callable and convertible features change how a preferred behaves.
• Preferred prices tend to react to interest rates much like bond prices.

This article is educational and is not investment advice.