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What Separates Common And Preferred Stocks?

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Preferred Stocks

Common and preferred stocks are two types of securities available in many different markets worldwide, including the United Arab Emirates. While these two types of securities may seem similar, several significant differences make them uniquely valuable for investors. This article will discuss critical differences between the UAE’s common and preferred stocks.

Dividends

One of the most important differences between common and preferred stocks is how dividends are handled. Dividends on common stocks are paid to all shareholders, regardless of how many shares they own. In contrast, dividends on preferred stocks are typically paid only to shareholders who own a certain minimum number of shares. Shareholders with preferred stock get their dividends before shareholders with common stock get theirs.

Voting rights

Another significant difference between common and preferred stocks is in their voting rights. Common stockholders generally have voting rights related to company decisions like corporate structure changes, mergers or acquisitions, changes in management, or dividend policies. Preferred stockholders do not typically have any voting rights.

Liquidation rights

Common stockholders are generally entitled to whatever assets remain after all creditors have been paid if a company goes bankrupt and is liquidated. In contrast, preferred stockholders typically have priority over common stockholders in the distribution of assets during liquidation. Therefore, they often receive at least a partial recovery even if the company does not have enough assets to repay everyone who is owed money.

Redemption rights

While preferred stocks can differ regarding dividends, voting rights, and liquidation rights, all preferred stocks have one crucial similarity: redemption rights. Redemption is the act of repurchasing shares of a company’s stock directly from its shareholders at a predetermined price or ratio. All preferred stockholders have redemption rights on their shares, meaning they are usually entitled to receive a payment if the company decides to repurchase them.

Asset-liability ratios

A final difference between common and preferred stocks is that preferred stocks are often considered to be less risky from the perspective of financial accounting. One reason for this is the fact that preferred stocks have lower asset-liability ratios than common stocks. These ratios help investors understand a company’s ability to meet its debt obligations and other financial commitments. A lower ratio means the company has more leeway to meet these obligations.

Market capitalisation

In addition to having different ratios than common stocks, preferred stocks often have lower market capitalisations. The total value of all outstanding shares of a company’s preferred stock is often much less than the value of its common stock.

Pricing

Because of their unique features, preferred stocks are often priced differently from common stocks. Common stock prices are typically determined by market forces and may fluctuate based on supply and demand in the marketplace. In contrast, the prices for preferred stocks are generally set by the company issuing them at a predetermined rate. Although these prices can change over time based on factors like interest rates or economic conditions, they tend to be more stable than common stock prices and less subject to market fluctuations.

Call option

Another essential factor that can affect the pricing of preferred stocks is whether or not they come with a call option. A call option is built into preferred stock agreements. It gives the company that issued them a contractual right to buy back their shares from shareholders in the future, typically for a predetermined amount. This option makes preferred stocks less risky for companies but may also decrease their value by increasing investors’ chances of losing money on their shares.

Tax treatment

One of the most important differences between common and preferred stocks is their tax treatment. Preferred stockholders are required to pay taxes on any dividends they receive, regardless of whether or not these dividends have been reinvested in more shares. It contrasts with common stockholders, who only need to pay taxes on dividends if they choose to sell their shares and realise a capital gain.

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