Common vs. Preferred Stock: Four Rights to Check Before Dividend Yield
Preferred stock is not inherently safer than common stock. Compare dividend priority, voting rights, cumulative dividends, conversion terms, and trading liquidity.
The central difference between common and preferred stock is the package of rights shareholders have in the company. Preferred stock may have priority for dividends or distributions of remaining assets, but terms vary across issues and dividend payments are not necessarily guaranteed.
Identify exactly what has priority
The U.S. SEC's introductory guidance generally describes preferred stock as having priority over common stock for dividends and liquidation distributions, with limited voting rights. Actual rights, however, depend on the jurisdiction and issuance terms. For Korean preferred stock, check the articles of incorporation and the share-class terms to establish what receives priority and by how much. Start by determining whether the dividend difference is based on par value or a specified amount. You cannot apply one company's preferred dividend formula to another company's shares.
Check cumulative dividends and conversion terms separately
Whether unpaid dividends accumulate into the next period, whether shares can convert into common stock, and whether the company can redeem them under specified conditions are separate rights. A statement that dividends have priority does not establish all three. When comparing preferred and common stock, examine voting rights, resources available to pay dividends, and the company's overall financial risk as well as expected dividends. If the company enters severe financial distress, a somewhat higher priority does not preserve your principal.
A price discount can also reflect trading costs
Preferred stock trading below common stock is not automatically a bargain. Low trading volume can make it difficult to buy or sell sufficient quantities at the displayed price and can widen the bid-ask spread. Conversely, a small number of trades can, in principle, push preferred stock above the common stock price. The price gap reflects a mix of market assessments of dividends, rights, and ease of trading. Comparing only dividend yields while omitting quotes and issuance terms leaves the comparison incomplete. In your comparison table, record the year underlying each expected dividend yield. Comparing last year's common dividend with this year's expected preferred dividend mixes differences in rights with differences in earnings expectations. Start with the same fiscal period and assumptions, then calculate the difference in dividends per share separately from the difference in market prices. In years with special dividends, show them on a separate line to avoid treating them as recurring payments.
Worked example
Hypothetical example: If common stock costs KRW 20,000 and its expected dividend is KRW 800, the simple dividend yield is 4%. If preferred stock costs KRW 16,000 and its expected dividend is KRW 850, the yield is approximately 5.31%. The difference is about 1.31 percentage points, but that does not mean the expected dividends are equally likely to be paid, or that voting rights and selling costs are the same. This calculation excludes taxes and fees.
What to check
- Have you read the specific formula for dividend priority?
- Have you checked cumulative dividend, conversion, and redemption terms separately?
- Have you compared the bid-ask spread and trading volume with those of common stock?
Sources and primary materials
This is educational material about research methods. For an actual company decision, verify the filings and primary sources for the relevant period.