Buying stocks is one of the options for earning income on the stock market. With their help, an investor can earn on the difference in the price of the asset, receive dividends, engage in long-term investment or buy a large share of shares and participate in the development of the company. The rights an investor obtains when buying shares depend on the type of shares purchased.
Globally, stock is divided into two types: preferred stock and common stock. What is the difference between preferred shares and common shares, what are they, their advantages and disadvantages? We give answers to these questions in the article, but first we suggest remembering what shares are in general.
Stocks are securities that a company issues in order to attract investment for development and further scale. When an investor buys shares, he or she becomes a shareholder and co-owner of the company. Depending on the type and number of shares, the investor receives different rights and privileges. He or she may receive a portion of the company's profits, dividends, or participation in management processes.
For example, an investor may acquire a controlling stake (50%+1) and receive full management rights over the company. In addition to the controlling interest, there is a majority interest. Owners of the majority stake own a stake (25%+1) and have the right to veto the decisions of the controlling shareholder to manage the company. Shareholders who own a few shares are called minority shareholders. They cannot manage the company, but they have the right to participate in votes, receive dividends, and receive a portion of the company's assets in the event of bankruptcy.
Common stock is the most common type of security on the stock market. Investors who buy common stock have the right to vote on a company's board of directors and to approve important corporate decisions. Holders of common stock also receive dividends, but not always regularly. If a company's profits go down, the board of directors has the right to reduce the dividend or cancel it altogether.
The most attractive prospect for buying common stock is to increase its value later on. If a company performs well in the market and raises its profits, the stock price rises and investors can make good money on the difference in value.
That said, if a company does poorly and declares bankruptcy, common stockholders, as co-owners of the company, are the last to be compensated.
The most promising common stocks are considered “blue chips”. These are the assets of the leading companies with the largest capitalization, which show high rates of return. Owners of blue chips receive profitable and stable dividends. Blue chip companies receive a flow of funds that allows them to share profits with stockholders through dividends. As profits rise, dividends often increase as well.
Let's start with the pros.
+ Provide a voice in the management of the company.
+ High potential yield in the event that the value of the stock rises.
+ A wide choice of assets on the stock market.
+ The ability to receive dividends.
Minuses of common stock.
- High volatility of assets and potential losses.
- There is a risk of not receiving dividends if the company's profits fall.
- When a company goes bankrupt, common stockholders are the last to receive compensation.
Preferred stock is an asset that is more like a bond in terms of how it works. The main advantage of preferred shares is a higher dividend yield. Preferred stock owners get priority in dividend payments and compensation in case of company bankruptcy. This type of stock is a great option for investors who are looking for a stable and regular return on investment and are not prepared for the potential risks of loss.
The amount of an investor's income, depends on the dividend rate. It is determined by several factors: profitability, dividend policy, and company goals. The combination of all these factors determines how much income per share an investor will receive in a reporting period.
There are two main types of preferred stock: cumulative and convertible.
- Cumulative. Their peculiarity is that in case of insufficient profit, the investor may be deprived of stable dividends. Such a decision is made by the shareholders' meeting. As soon as the income of the issuer reaches the expected bar, the entire amount of payments is returned to the holders.
- Convertible. This type of asset gives its holders the ability to convert their preferred shares into a fixed number of common shares after a predetermined date.
Like ordinary shares, preferred shares have advantages and disadvantages. Let's take a closer look at them.
Let's start with the pros.
+ Fixed income by receiving stable and regular dividends.
+ Low volatility of assets, so they can be used for long-term investment.
+ Compensation in preference in the event of bankruptcy of the company.
Minuses of preferred stocks.
- Lower yield compared to common stock.
- Lack of voting rights and inability to vote at shareholders' meetings.
- Lower liquidity than the common stock.
Common stock and preferred stock are two basic types of assets. But to make the right investment decision depending on your ultimate goals, it's important to understand exactly the differences between these assets.
Let's take a look at a comparison chart of the differences between common and preferred stock.
Firstly, it is important to determine your investment strategy. Preferred stocks are more suitable for long-term investments due to their high stability and regular dividends. In addition, this type of stock will suit investors who are not interested in actively participating in the development of the issuing company.
If an investor prefers to make money from speculative trading, seeks to participate in the management of the company, and is risk-averse, common stocks are an option. They are more volatile, but at the same time they offer a high potential return and the opportunity to contribute to the development of the company.
That's why it's important to start with your investment strategy, analyze the market and assess your risk appetite.
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