What Is The Difference Between Common Stock And Preferred Stock? A Complete Investor's Guide

When you’re first entering the stock market, one of the most confusing questions is understanding what distinguishes common stock from preferred stock. While both trade under the umbrella term “stock,” they operate under completely different rules, offer different returns, and suit different investor profiles. Let’s break down the key differences between common stock and preferred stock so you can make informed decisions.

Understanding Common Stock: The Everyday Investment Vehicle

Common stock represents the most basic form of equity ownership in a company. When news outlets report that “Company X shares rose 3% today,” they’re referring to common stock—not preferred. The major market indexes including the Dow Jones Industrial Average, the Standard & Poor’s 500, and the Nasdaq Composite all track common stocks exclusively.

From a company’s perspective, issuing common stock is the primary method to raise capital for operations and expansion. During an initial public offering (IPO), a company sells shares to the public for the first time, converting cash into equity. If additional funds are needed later, companies can issue more stock through follow-on offerings to finance acquisitions or growth initiatives.

As a common stock owner, you receive two critical rights: voting power and dividend eligibility. Shareholders can vote at annual meetings and special shareholder votes, giving them a voice in corporate direction. Additionally, if the company distributes profits through cash dividends—typically paid quarterly—common stockholders are eligible to receive them.

The Wealth-Building Potential Of Common Stock

The primary appeal of common stock lies in its capacity to generate substantial returns over time. A successful, growing company tends to see its stock price appreciate as investors recognize increasing profitability and future potential. The most successful stocks have delivered returns exceeding 20% annually for decades, while the S&P 500 index has historically averaged around 10% annual returns.

Common stocks reward investors through two mechanisms: price appreciation and dividend income. While many investors focus on capital gains, dividend-paying stocks attract those seeking regular income streams. High-quality companies often increase their annual dividends by approximately 10% yearly, making them particularly appealing to retirees and income-focused investors. These dividend-paying securities tend to demonstrate more stability than growth-focused stocks.

From a tax perspective, common stock offers advantages over preferred alternatives. You only owe capital gains taxes when you sell the shares, meaning decades of tax-free appreciation are possible. A stock held for 20 or 30 years could multiply many times without triggering any tax liability until sale. Dividends, however, do incur immediate taxation.

Why Companies Favor Common Stock Financing

Companies prefer common stock because it provides significant financial flexibility and stability. Unlike debt financing—where companies must pay predetermined interest regardless of profitability—common stock requires no mandatory payments. A company financed entirely through common stock cannot face bankruptcy from dividend obligations. This creates a safer capital structure for the business, though it transfers more risk to shareholders who receive no guaranteed returns.

Additionally, listing common stock on an exchange provides ongoing access to capital markets. If a company needs funds for expansion or acquisition, it can return to the market and issue more shares. This liquidity and prestige boost the company’s profile and employee morale.

Preferred Stock: The Bond-Like Hybrid Security

Despite its name, preferred stock functions more similarly to corporate bonds than traditional common stock. It pays fixed distributions on a regular schedule—typically quarterly—with a standard par value of $25 per share. Like bonds, preferred stock exhibits sensitivity to interest rate changes: prices rise when rates fall and decline when rates rise.

The “preferred” designation refers to its payment priority. When companies distribute earnings, preferred stockholders receive their full payout before common shareholders see anything—though bondholders get paid first. If a company cannot afford distributions, preferred shareholders maintain their claim while common shareholders receive nothing until the preferred obligation is satisfied.

Distinctive Features That Set Preferred Stock Apart

Higher Yields With More Risk Than Bonds Preferred stocks typically pay more than company bonds because they’re subordinate to debt in the capital structure. However, this doesn’t necessarily mean they’re risky—preferred stock from highly-rated companies remains quite safe, just relatively riskier than the bonds.

Perpetual Issuance Potential Unlike bonds with maturity dates, many preferred stocks can remain outstanding indefinitely. This perpetual status allows companies to tap permanent capital sources while potentially never redeeming the shares. Investors could theoretically hold the same preferred stock forever, collecting distributions indefinitely.

Dividend Flexibility One unusual feature: companies can skip preferred dividends without triggering default status (unlike bond payments). This flexibility does depress the stock price and prevents common stock distributions, but it’s not technically a financial default. The skipped dividend may or may not need repayment depending on whether the preferred is classified as cumulative or non-cumulative.

Cumulative vs. Non-Cumulative Structure Cumulative preferred shares require companies to repay all missed dividends before resuming regular distributions. Non-cumulative shares have no such obligation—missed payments simply vanish. This distinction significantly impacts investor risk profiles.

Industries That Frequently Issue Preferred Stock

Preferred stock issuance concentrates in specific sectors. Real Estate Investment Trusts (REITs), banks, insurance companies, utilities, and master limited partnerships dominate the preferred stock landscape. Financial institutions particularly favor non-cumulative preferreds because they count as equity rather than debt, allowing banks to strengthen their balance sheets while issuing debt-like securities.

REITs especially favor cumulative preferred structures. Since REITs exist solely to distribute earnings as dividends, they rarely cancel distributions without severe distress. When performance weakens, REITs often issue new common stock to purchase additional properties—protecting preferred dividend coverage while potentially diluting common shareholders.

Making Your Decision: Common vs. Preferred Stock

Your choice between common stock and preferred stock depends on your investment timeline, income needs, and risk tolerance.

Choose Common Stock If:

• You have decades before needing the capital
• You seek long-term wealth accumulation
• You can tolerate volatility for higher return potential
• You prefer voting rights and ownership influence
• You value tax-deferral advantages on unrealized gains

Choose Preferred Stock If:

• You need regular income now or soon
• You prefer lower volatility and higher yields
• You want greater downside protection than common stock
• You’re willing to accept limited upside potential
• You seek safer distributions than common dividends

Many investors build portfolios incorporating both securities, balancing growth potential with income stability.

Purchasing Common And Preferred Stock

Both security types are accessible through any online stock broker. The key distinction lies in ticker symbols. While companies typically issue one common stock, they may issue multiple preferred series designated by letters (Series A, Series B, Series D, etc.). Each series has unique terms, conditions, and characteristics.

For example, a REIT like Public Storage trades under the symbol PSA for common stock, while its preferred series use distinct tickers like PSA-PD for Series D or PSA-PE for Series E. Different brokers use varying notation systems (some use hyphens, others use periods or abbreviations), so verify the exact ticker before executing trades to avoid purchasing the wrong security.

The Bottom Line

Common stock and preferred stock represent fundamentally different investment vehicles serving different financial goals. Common stock offers ownership stakes, voting rights, and long-term appreciation potential—ideal for those building wealth over decades. Preferred stock provides steady income streams with more predictable returns—suitable for current income needs.

Your optimal strategy likely involves understanding both, then selecting the mix that aligns with your specific financial situation, investment timeline, and income requirements. Whether you focus exclusively on one type or combine both, informed selection based on these differences drives better investment outcomes.