TL;DR. Common stock and preferred stock are both equity, but they behave very differently. Common stock gives you a vote and uncapped upside — and puts you dead last in bankruptcy. Preferred stock usually strips out the vote in exchange for a fixed dividend that has to be paid before common shareholders see a cent, plus a senior claim on assets if the company is wound up. In practice, preferred stock looks like a stock on paper and trades like a bond.
The short answer
The U.S. Securities and Exchange Commission puts it in one line: common shareholders can “vote at shareholder meetings and receive dividends,” while preferred shareholders typically lack a vote but “receive dividend payments before common stockholders do, and have priority over common stockholders if the company goes bankrupt” (SEC Investor.gov). FINRA adds a market-behavior point most beginners miss: “the price of preferred stock…doesn’t move as much as common stock prices,” because the fixed dividend anchors it to interest rates rather than to earnings surprises (FINRA).
Everything else in this article is a variation on those two ideas.
Common stock, in one paragraph
When you buy a share of common stock, you own a slice of the company. You get one vote per share on things like board elections and major corporate actions. You may or may not get a dividend — and if you do, the board can cut it or drop it entirely at any time. FINRA is blunt: “the company can cut the amount of the dividend or eliminate it altogether.” In exchange for that uncertainty, your upside is uncapped. If earnings grow ten-fold, the share price can grow with them. If the company goes bankrupt, common stockholders are last in the payment queue — behind secured lenders, unsecured bondholders, and preferred shareholders — which almost always means they are wiped out.
Preferred stock, in one paragraph
Preferred stock is a hybrid instrument: legally it is equity, economically it is closer to a perpetual bond. A preferred share is typically issued at a fixed par value (often $25 or $1,000) with a fixed dividend rate quoted as a percentage of par. That dividend gets paid before any common dividend, but the trade-off is real: preferred usually carries no voting rights, and its price barely responds to good news about earnings — because you don’t get to keep that upside. If the company is wound up, preferred shareholders are paid before common shareholders but after bondholders and other creditors.
The six differences that actually matter
| Dimension | Common stock | Preferred stock |
|---|---|---|
| Voting rights | Yes — one vote per share (usually) | No, in most cases |
| Dividends | Variable; can be zero | Fixed rate on par value; paid first |
| Liquidation priority | Lowest — residual claim only | Ahead of common, behind all debt |
| Upside | Uncapped — grows with earnings | Capped by par + accrued dividends (unless convertible) |
| Price behavior | Driven by earnings, growth, sentiment | Driven mostly by interest rates & credit |
| Callable / redeemable | No | Often yes, at issuer’s option after a stated date |
Where you actually sit in the capital structure
Every claim on a company’s cash flow and assets sits in a legal queue. If the company defaults or is liquidated, cash gets paid to that queue in a strict top-down order. Think of it as a waterfall: the top bucket has to overflow before the next bucket sees a drop.
Two things follow from the waterfall. First, in a real bankruptcy, preferreds often recover partially while common gets zero — but if there isn’t enough left over after debt is paid, preferred can also be wiped out. Preferred is not safe; it is safer than common. Second, in a healthy company the waterfall barely matters day to day. What matters is that dividends flow in the same order: preferred first, common second, always.
A worked example: 100 shares, side by side
Assume you hold 100 shares of “WidgetCo,” a hypothetical mid-cap. The company has $2.00 of earnings per share this year and its board has declared:
- Common dividend: $0.40 per share (a 20% payout ratio).
- Preferred dividend: 6% on $25 par, i.e. $1.50 per preferred share per year.
The table below shows what those two positions actually look like side by side:
| Metric (100 shares) | Common stock | Preferred stock |
|---|---|---|
| Price / par | $40.00 | $25.00 par |
| Annual dividend / share | $0.40 | $1.50 |
| Annual dividend income | $40 | $150 |
| Yield on price / par | 1.0% | 6.0% |
| If earnings double next year | Dividend can rise; price likely rises materially | Dividend still $1.50; price barely moves |
| If board cuts common dividend | Your income falls | Your dividend is unaffected (must be paid first) |
| If company defaults | Likely wiped out | Paid after debt, before common |
This is why preferred is often described as an “income instrument that happens to be labelled equity.” The right question isn’t “which is better” but “which set of trade-offs do I want.”
Cumulative vs non-cumulative
Not every preferred is equal. The single most important sub-feature is cumulative vs non-cumulative:
- Cumulative preferred. If the company skips a preferred dividend, the missed amount accrues. Before any common dividend can ever be paid again, the company has to make up every skipped preferred payment. This is the standard for corporate preferreds outside of banking.
- Non-cumulative preferred. If the company skips a dividend, it’s gone. Preferred shareholders have no right to be made whole. Regulators like non-cumulative preferreds precisely because they can be turned off without triggering a default — which is why the perpetual preferreds banks issue to qualify as “Additional Tier 1” regulatory capital under the U.S. Basel III capital rule are structured as non-cumulative.
If you are buying a bank preferred, assume it is non-cumulative unless the prospectus says otherwise. If you are buying an industrial company’s preferred, cumulative is more common. Read the prospectus — a two-line difference can change your recovery in a stress event by an order of magnitude.
Convertible, callable, and other features to check
- Convertible preferred. Can be converted into a set number of common shares at the holder’s option. It is how you get the “bond-like income now, equity-like upside later” profile venture capital contracts love. If the common stock rips higher, convertibles participate; if it doesn’t, you keep collecting the dividend.
- Callable / redeemable. The issuer can buy the preferred back at par (usually plus any accrued dividend) after a stated call date. This caps your upside if rates fall — the company will simply call the old preferred and refinance at a lower rate. Almost every publicly traded preferred is callable.
- Perpetual vs term. Most publicly listed U.S. preferreds are perpetual: no maturity date. A few “term preferreds” carry a stated redemption date, which changes the analysis materially.
- Adjustable-rate vs fixed-rate. Fixed-rate preferreds pay a stated coupon forever. Adjustable-rate preferreds reset periodically off a benchmark like SOFR, which lowers interest-rate sensitivity in exchange for less predictable income.
Why price behavior looks so different
The chart below sketches, in stylised form, how the two instruments respond to a change in the market discount rate. Common stock trades on earnings expectations, so a rate move is one of several inputs. Preferred stock trades on a fixed cash flow, so a rate move dominates. If rates rise, a fixed-rate perpetual preferred falls in price the way a very-long-duration bond would; if rates fall, it rallies and then usually gets called.
A real example: Buffett’s Bank of America preferred
In August 2011, when Bank of America was reeling from mortgage-crisis litigation, Warren Buffett bought $5 billion of Bank of America cumulative perpetual preferred stock paying a 6% dividend, together with warrants to buy 700 million common shares at $7.14 anytime before September 2, 2021. That single sentence contains almost every preferred-stock feature that matters:
- The preferred gave Berkshire $300 million a year of contractual income, senior to the common dividend.
- The cumulative feature meant Bank of America couldn’t skip a Berkshire payment without eventually making it up.
- The perpetual feature meant no maturity: the income kept coming until the bank chose to redeem the preferred at par.
- The warrants on the common stock gave Berkshire the equity-like upside preferred alone would not have — and became the more valuable half of the package once Bank of America’s stock recovered well above the $7.14 strike.
The deal is a case study in why preferreds get structured with sweeteners. On its own, a 6% perpetual preferred is not a bargain in a normal market. Attach warrants, and the same instrument becomes the way a rational investor accepts a bank’s tail risk.
Common mistakes to avoid
- Assuming the dividend can’t be cut. A non-cumulative preferred dividend can be turned off with no legal consequence. Even a cumulative preferred dividend can be deferred for years in a stressed issuer.
- Ignoring the call date. Buying a 6% perpetual preferred at $27 when it’s callable at $25 next month is a way to lock in a loss. Always check the prospectus.
- Treating preferred yield as free income. A high preferred yield is compensation for something — usually credit risk, extension risk (perpetual duration), or call risk.
- Confusing preferred equity with senior debt. Preferred sits below every dollar of debt. If a company files bankruptcy, bondholders eat first.
- Missing the tax difference. Qualified common dividends and qualifying preferred dividends generally receive similar preferential U.S. tax treatment for individual holders, but some “trust preferred” securities pay interest that’s taxed as ordinary income. Read the prospectus, not the ticker.
Where preferred stock actually shows up
- Banks and insurance companies are the biggest issuers of publicly listed preferred. They use it because non-cumulative perpetual preferred qualifies as regulatory capital (“Additional Tier 1”) under the U.S. implementation of the Basel III capital rule (Federal Reserve press release).
- Real estate investment trusts (REITs) issue preferred because it counts as equity for their 90% payout tests but doesn’t dilute common shareholders’ upside.
- Utilities issue preferred because their stable, regulated cash flows can comfortably cover a fixed preferred coupon.
- Startups & VC-backed companies issue convertible preferred in private rounds. Each “Series A / B / C” is a class of preferred stock with its own liquidation preference and conversion terms — a fundamentally different beast from the publicly traded preferreds discussed above.
Related concepts
- Buybacks vs dividends — how the board decides what cash to send back and how.
- Convertible bonds — another hybrid instrument, one rung above preferred in the waterfall.
- Bond duration — why perpetual preferreds behave like ultra-long bonds when rates move.
- Investment-grade vs high-yield bonds — the debt claims that sit above preferred in the queue.
Sources
- SEC Investor.gov — Stocks — official definitions of common and preferred stock.
- FINRA — Stocks — features and risks of preferred versus common shares.
- Berkshire Hathaway 2011 Annual Letter (PDF) — Warren Buffett’s own description of the 2011 Bank of America preferred + warrants investment.
- Federal Reserve Board — Basel III final rule press release (July 2, 2013) — U.S. capital rule that treats non-cumulative perpetual preferred as Additional Tier 1 capital.
Disclosure: This article was produced with AI assistance and reviewed before publication. It is for informational purposes only and is not investment advice.