1

Forgive me but I'm totally ignorant on this regard. Given that I may not be able to ask the right question.

AFAIK, they differ in terms of how dividends are being paid and by how much. But do common stocks and preferred stocks have any differences in terms of the percentage of the company per unit they are representing? If they represent the same amount of shares or percentage of the company per unit, shouldn't they be sold at the same price and should be paying the same amount of dividends (or equivalent profit) per unit?

I'm simply trying to understand why there has to be a distinction between preferred stocks and common stocks. (i.e., why do we have preferred stocks and common stocks instead of just simply common stocks for simplicity's sake?)

3

Typically, preferred shares come with one or both different benefits - a disproportionate share of votes, say 10 votes per share vs the normal 1, or a preferred dividend.

The vote preference is great for the owner(s) looking to go public, but not lose control of the company. Say, I am a Walton (of Walmart fame) and when I went public, I sold 80% of the (1000 share total) company. But, in creating the share structure, 20% of shares were assigned 10 votes each. 800 shares now trade with 800 votes, 200 shares have 10 votes each or 2000 votes. So, there are still the 1000 shares but 2800 votes.

The 20% of shares now have 2000/2800 or 71% of the total votes. So, my shares are just less than half ownership, but over 78% of votes.

Preferred dividend is as simple as that, buy Stock A for ownership, or (same company) Stock A preferred shares which have ownership and $1/yr dividend.

Edited to show a bit more math. I use a simple example to call out a total 1000 shares. The percentages would be the same for a million or billion shares if 20% were a 10 vote preferred.

  • This is a good answer but the numbers in you second paragraph could use some clarifying. – Kevin Mar 7 '13 at 15:58
  • clarified, @Kevin. (I hope) – JoeTaxpayer Mar 8 '13 at 1:45
  • +1 for explaining why the company would want to sell preferred stocks. Are you implying here that both preferred and common stocks represent the same percentage of the company per unit? I'm not talking about the percentage of voting rights but the percentage of ownership itself. AFAIK percentage of ownership was meant for determining the amount of dividends (or profit) a shareholder should receive. If this simple rule is not applicable then I don't see any reasons why there should be percentage of ownership at all. It's pointless. I just can't make sense out of that intricacies about shares. – supertonsky Mar 8 '13 at 17:04
  • con't. Let's say a company is divided into 2 preferred stocks/shares (representing 2% of the comapny) and 98 common stocks/shares (representing 98% of the company). If the company earns $100, I think it would be unfair for the common shareholders if the preferred shareholders would receive more than $2 (> 2% of the total profit). Of course one would say that would be still be fair because preferred shares were sold at a higher price. In that case, why not just let the preferred shares represent higher percentage of the company per unit? Aren't preferred shares diluting the common shares? – supertonsky Mar 8 '13 at 17:23
  • "implying here that both preferred and common stocks represent the same percentage" - As @littleadv answered, they are preferred as they may have different preferences over the common. My examples were just that. Examples of how a preferred may differ. I leave as an exercise for the student to research particular stocks that trade different class shares to see how they function in real life. You can offer a case study as an answer, one example of an actual stock. – JoeTaxpayer Mar 8 '13 at 17:58
2

Preferred stocks are, err... Preferred.

The whole point of preferred stocks is that they have some preference over other classes of stocks (there may be more than 2, by the way). It can be more voting rights, more dividends or priority on dividends' distribution (common with VC investments), or priority on liquidations (in bankruptcy, preferred stock holders are ranked higher than common). Many times initial or critical investments are made on preferred terms, and the stocks are converted to common when certain thresholds are met.

Obviously all these benefits require a premium on the price.

  • I only answered when I saw you deleted your answer. I stole your suggestion of voting rights/ dividends. Full disclosure. I tell my 14 yr old, when they copy you, don't take offense, it means you're that good. – JoeTaxpayer Mar 8 '13 at 1:39
  • Well, I figured I'm answering too many questions so wanted to leave it blank for someone else to be the first:) – littleadv Mar 8 '13 at 1:42

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