Understanding Common and Preferred Stock
Investors often encounter various types of stock, primarily common and preferred, each having distinct characteristics that cater to different investor needs. Understanding these differences is crucial, especially for those preparing for the FINRA Series 7 exam—a certification that allows individuals to engage in a wide range of securities transactions.
Common Stock
Common stock represents ownership in a corporation and offers several enticing features:
- Voting Rights: Common stockholders typically have the right to vote on corporate matters, such as electing directors, mergers, and other significant decisions.
- Potential for Appreciation: Common stock has the potential for capital appreciation, as it can rise in value with the company’s success.
- Dividends: While not guaranteed, common stock can provide dividends, which are a share of profits distributed to shareholders.
Drawbacks of Common Stock:
- Variable Dividends: Dividends are not fixed and can fluctuate based on the company’s performance.
- Subordinate to Preferred Stock: In the event of liquidation, common shareholders are paid after preferred shareholders.
Preferred Stock
Preferred stock, on the other hand, offers different benefits and a more structured income stream:
- Fixed Dividends: Preferred stockholders receive dividends at a predetermined rate, which are typically prioritized over those of common stockholders.
- Priority in Assets: In the event of liquidation, preferred shareholders claim on assets before common shareholders.
Drawbacks of Preferred Stock:
- Limited Equity Participation: While preferred stock provides fixed dividends, it typically does not partake in further company earnings.
- Lack of Voting Rights: Most preferred stocks do not offer voting rights.
Key Takeaways
- Voting Rights: Common stock usually provides voting rights; preferred stock typically does not.
- Dividend Consistency: Preferred stock often comes with fixed dividends, while common stock dividends are variable.
- Claim on Assets: Preferred shareholders have a higher priority over common shareholders in liquidation scenarios.
- Participation in Company Growth: Common stock tends to offer greater potential for appreciation.
- Voting Rights: The ability of a shareholder to vote on corporate matters.
- Dividends: Payments made by a corporation to its shareholder members.
- Liquidation: The process of bringing a business to an end and distributing its assets to claimants.
- Capital Appreciation: An increase in the market value of an asset.
Additional Resources
Summary and Exam Preparation
Understanding the differences between common and preferred stock can greatly enhance an investor’s decision-making abilities. For those preparing for the Series 7 exam, it is essential to grasp these concepts to engage effectively in securities operations.
Explore the following quizzes to test your understanding:
### Which of the following is a characteristic of common stock?
- [x] Voting rights in corporate decisions
- [ ] Fixed dividends
- [ ] Priority claim in liquidation
- [ ] No potential for capital appreciation
> **Explanation:** Common stockholders often have voting rights on corporate matters like electing directors and mergers.
### What is one benefit of preferred stock over common stock?
- [x] Receives fixed dividends regularly
- [ ] Has voting rights
- [x] Priority during liquidation
- [ ] Greater potential for capital appreciation
> **Explanation:** Preferred stock generally provides fixed dividends and takes priority over common stock in liquidation scenarios.
### Which type of stock is more likely to appreciate in value over time with the success of the company?
- [x] Common stock
- [ ] Preferred stock
- [ ] Both have equal potential
- [ ] Neither appreciate
> **Explanation:** Common stock has greater potential for appreciation, as it rises with the success of the company.
### What typically happens to the dividends of common stockholders during poor economic conditions?
- [x] They may be reduced or eliminated
- [ ] They remain fixed
- [ ] They increase
- [ ] They convert to preferred stock
> **Explanation:** Common stock dividends are not guaranteed and may be reduced or eliminated during economic downturns.
### In an asset liquidation, who gets paid first?
- [x] Preferred stockholders
- [ ] Common stockholders
- [x] Bondholders
- [ ] Creditors
> **Explanation:** Preferred stockholders and creditors have priority over common stockholders in asset liquidation.
### What is a common drawback of preferred stock?
- [x] Lack of voting rights
- [ ] Priority in dividend payments
- [ ] Fixed dividend income
- [ ] Early liquidation rights
> **Explanation:** Preferred stock often comes without voting rights, unlike common stock.
### What advantage does common stock provide to an investor?
- [x] Voting rights
- [ ] Fixed dividends
- [x] Potential for capital growth
- [ ] Priority in liquidation
> **Explanation:** Common stockholder benefits include voting rights and the potential for capital growth.
### Are preferred dividends paid if common dividends are not declared?
- [x] Yes, preferred dividends take precedence
- [ ] No, they are the same
- [ ] Only in select companies
- [ ] None of the above
> **Explanation:** Preferred dividends are paid before common dividends, reflecting their precedence.
### Can preferred stockholders influence company decisions through voting?
- [x] No, they typically lack voting rights
- [ ] Yes, like common stockholders
- [ ] Only under specific circumstances
- [ ] None of the above
> **Explanation:** Preferred stockholders generally do not have voting rights, unlike common stockholders.
### True or False: Common stockholders are prioritized in receiving dividends over preferred stockholders.
- [ ] True
- [x] False
> **Explanation:** Preferred stockholders typically receive dividends before common stockholders because of their prioritized status.