What is Preferred stock and how it’s different from common stock

A company’s stock can be divided into two major types: Common stock or equity shares and Preferred stock or preference shares.

Both type of stocks are split into smaller pieces known as shares. Owners of theses shares are known as shareholders or stockholders. In this article, we will discuss what is preferred stock and how it’s different from common shares.

Common stock is also referred to as ordinary equity shares or own capital. Its created with the contributed capital of ordinary shareholders and retained earnings.

Retained earning is the wealth accumulated by the company over the years from its net profit after paying out dividends. If the company is in loss, instead of accumulated earnings they will be showing accumulated losses as part of equity capital on the balance sheet.

As the name suggests preferred stockholders are given preference to receive income ahead of common shareholders. For instance, company while paying dividend, it must be first paid to preferred stockholders before paying to common stockholders.

However, both have no legal rights to claim dividend. It’s up to the board of directors to decide whether dividend will be paid or not.

Preferred stocks are a hybrid of both equity and debt. Owners of preferred stocks have preference over equity shares in getting company’s earnings as dividend and also have preference in assets in case of bankruptcy or liquidation.

In case of liquidation, preference shareholders have the right to the income and assets of the company ahead of common shareholders. Common stockholders get what is left over after paying to creditors and preference shareholders.

In general, preferred stockholders do not have any voting rights. However, if the company fails to pay the promised preferred dividend, then voting rights may become active.

Preferred stock is a form of ownership which has preference over the common shareholders ownership. It can also be convertible to ordinary shares. This means in convertible preference shares, the owners can exchange it for ordinary shares. It can also be issued as mandatory convertible preferred stocks. This type of stock requires the investors to convert the preferred shares into common shares within a specified period of time.

is a fellow member of the Institute of Chartered Accountants of India. He lives in Bhubaneswar, India. He writes about personal finance, income tax, goods and services tax (GST), company law and other topics on finance. Follow him on facebook or instagram or twitter.