Analyzing Preferred and Common Stock

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Common vs. Preferred Stock

Preferred and common stocks are different in two key aspects.

Firstly, stockholders who are preferred have a bigger claim to organizational earnings and assets. This holds true in good times, i.e., when the firm possesses excess money and decides upon distributing it as dividends to company financiers. In such cases, during distributions, preferred stockholders are to be paid prior to common stockholders. But the claim of preferred stockholders is most crucial, if the organization goes insolvent, when it's common stockholders that come last in claiming company assets. That is, if it comes down to liquidation and paying of all bondholders and creditors, common stockholders receive nothing, unless all preferred shareholders receive their due (Bratton & Wachter, 2013).

Secondly, preferred stock dividends differ from, and are generally higher than common stock dividends. When purchasing preferred stocks, the investor will know when a dividend is to be expected, as these are paid out regularly. However, this doesn't necessarily happen with common stock, since the directorial board of the organization has the authority to decide whether to pay common dividends or not. Owing to this characteristic, normally, preferred stocks do not fluctuate with the same frequency as common stocks do, and can, at times, be categorized as fixed-income securities. To add to preferred stocks' fixed-income nature, dividends are generally, guaranteed, i.e., if the organization misses one, it has to disburse it prior to disbursing any further dividends on either of the two stocks (Bratton & Wachter, 2013).

But there are a few situations wherein common stock owners have more rights compared to preferred stock owners. Chief among these situations is: common stockholders generally have voting rights with regard to board decisions or corporate policy, while preferred stockholders don't. Preferred stocks are associated with the advantage of lesser volatility compared to common stocks; however, with regard to potential appreciation, preferred stockholders have a relative disadvantage. Organizational achievements (like a major acquisition or innovation), or events leading to skyrocketing of common stock prices, can have a relatively smaller impact on the value of preferred stock. Thus, growth investors might not be drawn to the idea of holding preferred stocks of a company. But, income investors typically prefer the stronger position of fixed income that preferred stocks offer (Schowitz & Albrecht, 2014).

Much of preferred stock can be redeemed or repurchased by the organization, normally after some specific date; i.e., it is callable. Hence, unlike common shareholders, those holding preferred stocks might need to surrender investments before they wish to, as well as in a manner that stops them from the realization of some of their expected income from stocks (Schowitz & Albrecht, 2014).

Why would an investor (current investor) have a negative reaction to the issuance of additional shares of common stock?

If some new constituent gets incorporated into a stock index, its market value, earnings, and other properties simply get added to corresponding index aggregates. But current investors don't have any claim to the new earnings; they will have to purchase stock of the new addition (i.e., new company) for any extra earnings, by diluting their current holdings or investing novel capital. A commonly made mistake is assuming investor dividends and earnings can grow in proportion to, or perhaps, over and above, overall gross domestic product (GDP or economic growth) in perpetuity. Even assuming this, the fact that aggregate income has to, in the long run, keep pace with the overall economy, is virtually a truism; otherwise, earnings would ultimately surpass the whole economy's size or decline to insignificance. However, all this growth in earnings doesn't accrue to current shareholders. In contrast, a large share of economic expansion arises out of the establishment of new businesses. It is suggested by some commentators that fresh businesses make up over 50% of America's GDP growth, while in a few rapidly growing economies, novel companies might make up the majority of their overall economic growth (Schowitz & Albrecht, 2014).

As current shareholders aren't entitled to new additions' (i.e. enterprises') earnings till they invest in them through dilution of current holdings or through new capital, slippage or continual dilution can be witnessed between investors' earnings per share (EPS) and aggregate earnings growth (Schowitz & Albrecht, 2014).

Legal or regulatory considerations to address when analyzing the impact on the firm for the issuance of stock