Preference Stocks and Equity Stocks

There are two categories of stocks:

1. Preference stocks, and 2. Equity stocks.

Preference stocks give a fixed rate of dividend, which is currently around 6 to 8 per cent per annum. Preferential stocks give a right to their holders to receive dividends and repayment of capital in case the company is wound up in preference to equity stockholders. Companies which make losses are sometimes not in a position to pay any dividends to their preference stockholders. To provide for such an eventuality, companies issue what are called cumulative preference stocks. Unpaid dividends on these stocks do not lapse, but are allowed to accumulate till the company is in a position to clear all the arrears of accumulated dividends. A company cannot pay any dividends to its equity stockholders until all such arrears of accumulated preference dividends have been paid. This gives added security to preference stockholders by assuring them of their fixed dividend, irrespective of the extent of losses which the company may incur.

The stock capital of a company is not refunded to the stockholder so long as the company is in existence. However, an exception is usually made in the case of holders of redeemable preference stocks as their stock capital can be refunded, or "redeemed" from the company after a certain fixed period of time.

Equity stocks, on the other hand, don't carry a fixed rate of dividend. In fact, equity stockholders cannot claim dividends as a matter of right. Since equity stockholders are the owners of the company, they are entitled to all the residual profits and accumulated reserves of the company after all its obligations to its creditors and preference stockholders have been met.

Equity stockholders form a bulk of the stockholders of a company. They exercise full voting power on all important matters affecting the company. When a company makes large profits, the lion's stock goes to its equity stockholders. Conversely, when profits go down it is the equity stockholders who have to bear the brunt and are often deprived of even a modest dividend.

In growing and expanding companies, an equity stockholder gets a much higher rate of return on his investment than does a preference stockholder. The latter gets only his fixed rate of dividend, whereas the former gets the double benefit of substantial capital appreciation, plus higher dividends. His stockholding also expands with the addition of rights and bonus stocks. A preference stockholder does not get the benefits of capital appreciation on his investment. Thus an equity stockholder bears higher risks than the preference stockholder and, in return, is rewarded with higher profits. Finally, it is the equity stockholder who experiences the excitement and thrills of stock market investment.