Definition & Meaning:

If you want to buy stock/shares in companies on the stock market, there are two main types that you can choose to buy; 'common stock' and 'preferred stock'. Of the two, 'common stock' is by far the most common stock/shares that you can buy in companies.

The main difference between the two is the 'dividend' (the annual payment you receive for owning shares in a company) you receive. With 'preferred stock', the amount of dividend doesn't change. You are guaranteed to receive a fixed 'dividend' every year during a fixed amount of time no matter how the company performs (you'll receive the same amount of dividend if company makes a large profit or makes no profit at all).

With 'common stock' (which are the most common type of shares bought in companies on the stock market which are often just called 'shares'), the amount of dividend you receive each year can change. It is normally based on the company's profit performance. So, if the company makes a large profit, you should receive a large dividend. But if the company makes no profit, you'll receive no dividend.

You may have noticed that above I said that you 'should' receive a large dividend if a company makes a large profit. The reason that it is not 'will', is that with 'common stock' the amount of dividend paid out to shareholders each year is decided by the company. They can pay out as much or as little of the profit they make as a dividend to the shareholders that they want (for many years Apple made large profits but didn't pay out dividends on 'common stock', they kept all their profit as 'retained earning' in the company).

This makes 'common stock' a riskier way of investing your money in a company on the stock market than by owning 'preferred stock'.

In addition to not being guaranteed a 'dividend', in the unfortunate event of the company going bankrupt, people who own 'common stock' will be the last to receive any money from the selling of the company's assets (buildings, machinery etc...). The government, the company's creditors and owners of 'preferred stock' are all paid money from the sale before any money is given to owners of 'common stock'. Which means the likelihood you will loss all the money you paid for the 'common stock' if the company goes bankrupt is very high.

Although 'common stock' is riskier than 'preferred stock', the dividend paid out to owners of 'common stock' is generally a lot higher over time than to owners of 'preferred stock'. For some, this makes the risk of buying 'common stock' worthwhile.

Apart from the level of risk and dividend, the other main difference between the two types of stock is 'voting'. With 'common stock' you can vote at shareholder meetings to decide who runs the company and the direction the company goes in. With 'preferred stock', you can't.

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Also Called:

Shares, Ordinary Shares.

Related Vocabulary:

Preferred Stock, Dividend, Retained Earnings

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