What are the similarities and differences between preferred stock, common stock and bonds.

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kipling2448 | (Level 3) Educator Emeritus

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The fundamental distinction between common and preferred stocks is essentially the preferential treatment afforded holders of the latter when the company in question is distributing dividends.  Common stocks, so-called because they are more common, represent basic shares in the ownership of a publicly-traded company.  The greater the percentage of total shares of a company’s stock one owns, the greater the influence that individual generally has in corporate policy and practices.  Holders of common stocks receive quarterly dividends, which are a share of the company’s profits distributed in direct correlation to the number of shares (or percentage of ownership) an individual owns.  Holders of common stocks also enjoy voting rights during shareholder meetings during which some decisions regarding corporate policies are made, for example, whether a company should do business with foreign countries with bad human rights practices. 

Unlike common stocks, preferred stocks do not come with a vote on corporate policies, which is a key distinction between the two types of stocks.  Additionally, whereas the dividends paid out to holders of common stocks are determined by the company’s profit margin, holders of preferred stocks receive a fixed rate irrespective of profitability.  Consequently, an increase in a company’s profitability does not benefit holders of preferred stocks as much as it does holders of common stocks.  Also, should the company face financial difficulties or file for bankruptcy protections, thereby signaling its inability to pay out dividends to all stockholders, holders of preferred stocks receive preferential treatment; in effect, they move to the head of the line in terms of who receives dividend payments first.  Finally, should the company declare bankruptcy, holders of preferred stocks are first in line to claim corporate assets in lieu of the dividends that otherwise would have come their way.

Bonds are a different type of financial instrument, especially savings bonds.   They are, essentially, a loan provided to the issuer of the bond, including, the federal government, in exchange for repayment with interest following a predetermined period of time.  When someone buys a U.S. Government bond, he or she is literally loaning money to the government with the assurance that the government will repay that loan five, ten or twenty years down the road, with interest.  Bonds are basically a low-risk, low-yield form of investment.  Many localities issue bonds as a means of financing projects that would not otherwise be financed in their entirety through tax revenues.  In those cases, registered voters determine whether the locality in question will be authorized to issue bonds for the purpose of funding specific projects, such as construction of a new stadium. 

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