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Preferred Vs. Common StockIntroductionSome corporations issue both common and preferred stock. Each provides unique benefits to investors. Both common and preferred shareholders own a portion of the company, but they have very different rights. Common stock confers voting and pre-emptive rights. Preferred stock may trade voting and pre-emptive rights for dividends and a higher claim to liquidated company assets than common stock. Regardless of whether you choose common or preferred stock you should always read the prospectus before investing. In this section, we will first explain shareholder rights and privileges, followed by common and preferred stocks and their respective properties. For common stock, we will cover these topics: For preferred stock will cover these areas:
Shareholders' Rights and PrivilegesShareholders may acquire the following rights and privileges when they purchase shares of a company's common or preferred stock (although preferred shareholders may have theirs restricted or applied only in certain situations). Voting RightsOwners of common stock have the right to vote on company matters. For example, they can vote on whether to allow a stock split, or whether the objective of the company should be changed. They cannot, however, vote on whether dividends should be distributed. A shareholder has one vote for each share owned. To cast their votes, most shareholders use a form of absentee ballot called a proxy. Shareholders also elect the management of the corporation. There are two methods of voting. The statutory method provides one vote per share for each vacant seat; this method benefits those who hold many shares. The cumulative method allows those who do not own many shares to have as many votes as there are seats to be filled. Shareholders can cast all their votes for one candidate or distribute their votes among several. For example, if five directors were to be elected, an owner of 30 shares of stock with the cumulative voting right would have 150 votes that they could cast for one director or spread among the five directors. Preemptive RightsPreemptive rights may give shareholders the right to keep their proportionate ownership of the company. If the company offers a new issue of stock to the public, shareholders are accorded the right to buy new shares to keep their percentage of ownership the same. With preemptive rights, they can maintain voting control, share of earnings and share of assets. Preemptive rights let common shareholders buy new shares of stock before non-stockholders. Thus, these rights assure the keeping of previous percentages of ownership. They must be exercised within 45 days. If they are not, the company may sell the stock to non-shareholders. Other Rights of Common StockholdersShareholders have the right to inspect the books and records of the company. They also have the right to sue the management for any unauthorized activities. They have the privilege of receiving dividends as cash, stock or property. The board of directors, however, is allowed to forego paying dividends if it feels that doing so is against the best interests of the corporation. Stockholders also have the right to receive distributions of any remaining assets should the company go out of business. However, as stated before, they are last in line for the asset-claiming privilege. Preferred shareholders are paid before common shareholders.
An Overview of Common StockCommon stock represents ownership in a corporation. Common stock dividends may be paid in cash, stock or property. The most common payment method is a cash dividend. The board of directors determines whether or not to pay dividends to common shareholders. Increases or reductions in dividend payments most frequently depend on how well the company is performing. In a weak economy the company may even suspend dividends until its balance sheet improves. Should the corporation issuing the stock go bankrupt, it may have to liquidate its assets in order to pay its creditors. Common stockholders will receive payment for their ownership interest only after all other creditors, the bondholders, and preferred shareholders have been paid.
Types of Stock DividendsStock pays dividends in three forms: cash, stock and property. Let's take a look at each one. Cash dividends are those that are paid out in cash form. They are treated as investment income and are taxable in the year they are paid. Stock dividends are dividends paid out in the form of additional stock shares in the corporation, or shares of a subsidiary corporation. They are usually issued in proportion to shares owned. For example, for every 100 shares of stock owned, a four percent stock dividend will yield four extra shares. When the company distributes these new shares to investors, the price of each share decreases to account for the new shares. This is a recalculation of cost basis. It means that the stock dividends will not be taxed when distributed. Stock dividends benefit the company by conserving its cash and they benefit the shareholder by increasing his/her number of shares of the company. Property dividends are paid with assets owned by the issuing company. Property dividends are usually paid in the form of products or services that the corporation produces. Often the corporation, when paying property dividends, will use securities of other companies owned by the issuer. This concludes our look at common stock. Read below to learn about preferred stock ownership.
An Overview of Preferred StockPreferred stock also represents ownership in a corporation. Preferred stock promises guaranteed dividends and a claim on a company's assets that is above that of common shareholders. The trade-off may be that preferred shareholders cannot vote or share other specified rights. Preferred stock pays a fixed dividend that is specified and set down in advance. Unless the stock is retired or called back, it will continue paying dividends forever. Preferred stock is usually issued with a $100 par (face) value. The dividend payments are a fixed percentage of the par. For example, if the par value of a stock share were $100 with a six percent annual dividend rate, the annual dividend would be $6 on that share. In recent years, some companies have also begun issuing preferred shares with variable rates tied to interest rates. The par value is the most that the shareholder will receive if the company declares bankruptcy. Preferred stock is generally issued at its par value.
Types of Preferred StockPreferred stock further divides into four types: cumulative, non-cumulative, participating and convertible. Cumulative preferred stock accords its owner a continuous claim to his or her dividends. Any unpaid dividends accumulate until the corporation resumes paying them. Since the cumulative preferred owner is entitled to all past and present dividends, he or she is paid before common shareholders once payment is resumed. If the board of directors suspends dividends, the shareholder still has a claim on them. Non-cumulative (straight) preferred is the opposite of cumulative preferred: it doesn't confer a steady claim on dividends in the event of a dividend suspension. Shareholders of this type may not be paid any missed dividends prior to payments being made to the common shareholders. Participating preferred shareholders receive extra dividends over their normal ones when the company makes an extra profit and the board of directors declares dividends. Convertible preferred stock may be converted to a certain number of shares of common stock. Preferred investors who want the opportunity to share in the appreciation of the company's common stock may find this option attractive. Preferred stock has features other than fixed, steady dividends. The next section will explain these features.
Features of Preferred StockLimited Voting RightsPreferred stockholders may be limited to voting only in these situations:
Call ProvisionsPreferred stock may carry a call provision. This means that the issuing company can repurchase the stock from the shareholders. Though preferred stock is usually called at par value, some call provisions actually tack on a premium. Because of the steady dividends accorded to preferred shareholders, call provisions are not usually advantageous to them, despite any premiums. However, a corporation may use calls as a way to eliminate dividends, thus increasing earnings for common shareholders.
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