Question

What are advantages and disadvantages of Preferred Stock? Do they outweigh the advantages and disadvantages of Common Stock?

Answer 1

preferred stock have a seniority which is above the common stock but below the debt holders. in the event of liquidation payment is made first to the debt holders before any payment can be made to the holders of the preferred stock.

advantages of preferred stock:

• payment of dividends: in the case of dividends, the preferred stock holders are paid before the common stock holders but after any payment of interest obligations to the debt holders.
• liquid stocks: most preferred stocks are liquid ,they trade in fewer lots as against debt which trade in bigger lot sizes.
• lower tax rates : the preferred dividends are taxed at a lower rate.

disadvantages :

• the preferred stock holders do not have rights to vote for the board of directors, but when it comes to participating in the important relating to the company like changes in capital structure,merger,acquisition,changes in remuneration.then they usually have a say in such matters.
• preferred stocks are exposed to interest rate risk: as most fixed income instruments, the preferred stock is also exposed interest rate risk, it's prices fall with the rise in interest rate and rises with the fall in interest rates.
• preferred stock holders are also exposed to credit risk. the risk of defaulting on the dividend payments arise ,as payments are first to be made to the debt holders.a company can avoid making payments to the preferred stock holders to avoid defaulting on its debt.

advantages of common stock:

• stock holders enjoy dividends on stock as well as capital appreciation. when the prices of stocks rises, the holder of the stock enjoy capital appreciation.
• the common stocks are highly liquid and it is very easy to trade these stocks on the exchange. they can be easily bought and sold with a small amount of fees paid as brokerage on these transactions.
• unlike preferred stocks, the common stocks are not exposed to interest rate risk. during volatile markets the stocks under perform but are not at its worst.
• common stocks holders have no legal implications concerning any fraudulent practices adopted by the firm.
• voting rights given to the common stock holders : they have a right to vote in the appointment of the directors in the company. they can also vote on all the crucial matters of the company like mergers,acquisitions and compensation of the directors.

disadvantages:

• the common stock holders are given last priority in the event of liquidation. any payments if made are made first to the outsiders,creditors,preferred stock holders and only then to the common stock holders.
• the company may or may not pay dividends to the common stock holders, if the company decides to reinvest their earnings instead of distributing them as dividends. then they might not receive may dividends.
• taxes are paid on the capital gains earned on a stock.

no, the advantages of preferred stock do not outweigh the common stock.