The two main types of stock sold by companies and traded by investors on the open market are common stock and preferred stock. Both types of stock give a stockholder partial ownership in the company, and both have advantages and disadvantages. Whether an investor chooses preferred stock or common stock most likely depends on his investment strategy, the amount of risk he is willing to take, and the specific rights attendant to the security.
Preferred stock is a hybrid between stocks and bonds and is generally less volatile, and therefore less risky than common stock, but typically offers less potential for profit. Instead of the investment moving up and down with the market, the preferred shareholder receives dividends. These dividends are fixed, regular payments that are paid for a specific period of time. However, these payments are not based on company performance and usually do not increase over time.
Owning preferred stock is advantageous because a shareholder receives dividends before common shareholders, and these dividend payments are generally higher, making yields attractive to potential investors. However, dividends rest upon a company's ability to pay. If a company is unable to pay, the dividend amounts are accumulated and will be paid when the company's finances are better. In the event of bankruptcy, preferred stockholders are paid before common stock shareholders, but only after debt holders have been paid.
Many preferred shares come with a bonus in the form of a conversion option. These are called convertible preferred shares (see the U.S. Securities and Exchange commission at http://www.sec.gov/answers/convertibles.htm for further detail). The conversion option allows investors to turn preferred shares into common shares at a certain price. For example, if a stock is trading at $10, and the company's convertible shares can be converted at $20, the preferred shareholder only gets the preferred dividend payment. However, if the stock reaches $50, the preferred shareholder can convert the shares into common shares for $20 and can make a profit of $30 per share.
