The two main categories of stocks on the Nigerian stock market are common stocks and preferred stocks.

What are Common Stocks?

Common stocks are the most prevalent type of stocks issued by publicly traded companies. When you purchase common stocks, you become a shareholder with voting rights. Common stocks also provide investors with the potential for capital appreciation. If the company performs well and its stock price rises, the value of your investment could increase significantly. However, common stocks are subject to market volatility, meaning their prices can fluctuate dramatically based on market conditions.

Common stockholders are also at the bottom of the priority ladder regarding claims on a company’s assets or earnings. In other words, in the event of bankruptcy or liquidation, common shareholders are the last to be paid.

What are Preferred Stocks?

Unlike common stocks, preferred stocks do not typically come with voting rights. They are a different class of ownership in a company that combines features of both equity and debt. Investors in preferred stocks are given priority over common shareholders in receiving dividends and in asset liquidation scenarios. This means if the company distributes dividends, preferred shareholders receive theirs before common shareholders. Also, in the event of liquidation, preferred stockholders have a higher claim to the company’s assets than common stockholders.

While preferred stocks provide a steady income, they typically do not appreciate as much as common stocks. This is because they are less likely to benefit from the company’s growth in the way common stocks do.

Key Differences Between Preferred Stocks and Common Stocks

Ownership Rights: Common stockholders have the right to vote at shareholder meetings, influencing the company’s strategic direction. Preferred stockholders, on the other hand, usually do not have voting rights, meaning they cannot participate in the decision-making process.

Dividend Payments: Preferred stocks offer fixed dividends, which are paid out before any dividends are given to common shareholders. This makes them attractive to income-focused investors who prefer stability and predictability. Common stocks, however, may provide variable dividends based on the company’s profitability, and there is no guarantee that dividends will be paid at all.

Risk Factor: Preferred stocks are generally considered less risky than common stocks because of their priority in receiving dividends and asset liquidation payouts. This makes them more suitable for conservative investors. Conversely, common stocks are seen as higher risk due to their market volatility and lower claim on a company’s assets.

Potential for Growth: Common stocks have a higher potential for capital appreciation. If the company grows and performs well, the stock price of common shares may increase significantly, providing substantial returns for investors. Preferred stocks, however, usually come with less potential for capital appreciation, as they are often issued at a fixed par value.

Market Price Volatility: Common stocks are more prone to market fluctuations and can experience significant price volatility due to market sentiment, economic conditions, and company performance. Preferred stocks, in contrast, are generally less volatile and tend to maintain a more stable price due to their fixed dividend payments.

Why Would a Company Issue Preferred Shares Instead of Common Shares?

Raise Capital Without Dilution of Control: Preferred stocks allow companies to raise capital without giving up voting rights. This can be particularly appealing for founders or key stakeholders who want to maintain control over the company’s strategic direction.

Attracting a Different Type of Investor: Preferred shares are designed to attract more conservative investors, such as pension funds, insurance companies, and retirees, who prioritize steady income over capital gains.

Flexibility in Financing: Preferred shares can be structured in various ways, such as cumulative, non-cumulative, or convertible preferred shares, giving companies flexibility in their financing options. This can be beneficial in managing cash flow and optimizing the capital structure.

Is Preferred Stock Better Than Common Stock?

The answer to this question depends on the investor’s goals. If you are looking for stable dividends and lower risk, preferred stocks may be the better choice. However, if you are looking for capital appreciation and are willing to take on more risk, common stocks could be more suitable.

Who Buys Preferred Stock?

Preferred stocks are often bought by conservative investors seeking a steady income. They are also popular among institutional investors, such as mutual funds and pension funds, that require stable dividends and lower risk.

Pros and Cons of Preferred Stocks and Common Stocks

Conclusion

Choosing between preferred stocks and common stocks ultimately comes down to your individual investment objectives and risk tolerance. Preferred stocks are ideal for investors looking for a stable income with less risk, while common stocks are suited for those who aim for higher returns through capital appreciation and can tolerate more risk. Understanding the unique characteristics of each stock type will help you make informed decisions in your journey through the Nigerian stock market.

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