What is Stock in Accounting? (Part 2)

What is Common Stock and Preferred Stock?

Common Stock

The holders of common stock can reap two main benefits: capital appreciation and dividends. Capital appreciation occurs when a stock's value increases over the amount initially paid for it. The stockholder makes a profit by selling the stock at its current market value after capital appreciation.

Dividends, which are taxable payments, are paid to a company's shareholders from retained or current earnings. Typically, dividends are paid to stockholders on a quarterly basis. Payments are usually made in the form of cash, but other property or stock can also be used. Payment of dividends, however, hinges on a company's capacity to grow -- or maintain -- current or retained earnings. This means ongoing payment of dividends cannot be guaranteed.

Common stock has the additional benefit of enabling its holders to vote on company issues and when choosing the company's leadership. Usually, one share of common stock equals one vote.

Preferred Stock

Preferred stock doesn't offer the same profit potential as common stock, but it’s a more stable investment vehicle because it guarantees a regular dividend that isn't directly tied to the market as with the price of common stock. Preferred stock guarantees dividends, which common stock does not. The price of preferred stock is tied to interest rate levels; it tends to decrease if interest rates go up and increase if interest rates fall.

Preferred stockholders get priority when it comes to the payment of dividends. If a company is liquidated, preferred stockholders get paid before those who own common stock. In addition, if a company goes bankrupt, preferred stockholders enjoy priority distribution of the company's assets; holders of common stock don't receive any corporate assets until preferred stockholders have been compensated.

Like common stock, preferred stock represents ownership in a company. However, owners of preferred stock do not get voting rights in the business.

The difference between Common Stock and Preferred Stock

Common Stock	Preferred Stock
The capital stock (or simply stock) of a business entity represents the original capital paid into or invested in the business by its founders. It's a security for creditors since it cannot be withdrawn to the detriment of the creditors.	Preferred stock, also called preferred shares, preference shares, or simply preferred, is a special equity security that has properties of both equity and a debt instrument and is generally considered a hybrid instrument.