Complete Guide: Understanding Common and Preferred Shares for Investors

When an investor seeks to diversify their portfolio, one of the first challenges is understanding that not all stocks perform the same way. Companies can issue multiple categories of equity interests, each with different rules and benefits. This article will show you how to navigate between common and preferred stocks, two fundamental instruments for building a solid investment strategy.

The Dual Nature: Common vs Preferred Stocks

There are mainly two categories of stocks that corporations place on the market, and their characteristics are practically opposite in terms of rights and benefits.

Preferred stocks occupy a hybrid territory between debt and equity. Their name reflects their essence: they offer priority in dividend payments but waive political rights within the company. These securities generate more stable income, often with fixed or predetermined rates, without the legal obligation of capital repayment that characterizes traditional bonds.

Common stocks, on the other hand, represent the most traditional form of equity participation. Holders of these securities not only receive a share of the company but also have a voice in corporate decisions and the potential to benefit from business growth through capital appreciation.

Breaking Down the Rights: What You Have and What You Lose

Voting Power: The Decisive Factor

Common stocks grant their holders the fundamental right to participate in shareholder meetings, allowing influence over critical decisions such as electing the board of directors. This means investors have a voice in the company’s direction.

Preferred stocks, conversely, lack this voting power. This renunciation is the price investors pay for more predictable income. However, among variants of common stocks, some are issued without voting rights, and there are also multi-class structures where different categories have different voting rights, enabling certain groups to maintain significant control even with lower ownership stakes.

Income Stream: Stability versus Variability

A central difference lies in how profits are distributed. Preferred stocks guarantee a relatively constant dividend flow, calculated on a fixed or preferred rate. Many include cumulative features: if the company does not pay dividends in a period, these accumulate and are paid later, offering greater security to the investor.

Common stocks present a more dynamic outlook. Their dividends fluctuate according to the company’s financial performance. During prosperous years, shareholders might receive generous distributions; in difficult times, dividends can be drastically reduced or disappear entirely.

Hierarchy in Times of Crisis

In case of bankruptcy or liquidation, there is a priority order for recovering investments. Creditors and bondholders are paid first. Next come preferred stockholders, who have priority over common shareholders. Holders of common stocks occupy the lowest position in the hierarchy, meaning they might recover little or nothing if the company has insufficient assets after paying other creditors.

Extended Types of Preferred Stocks

The market has developed sophisticated variants to meet different investment needs:

Cumulative Preferred Stocks accumulate unpaid dividends for later periods, ensuring the investor will not lose these income streams.

Non-Cumulative Preferred Stocks do not offer protection if a dividend payment is omitted in a given period.

Convertible Preferred Stocks can be transformed into common stocks under specific conditions, providing strategic flexibility.

Redeemable Preferred Stocks allow the company to buy back these securities, potentially limiting the investment horizon.

Participating Preferred Stocks link dividends to the company’s actual financial results, combining elements of both types of stocks.

Some issues also include clauses for protection against specific events, automatically adjusting terms if control changes or restructurings occur.

Comparative Analysis: Performance and Market Behavior

To contextualize these theoretical differences with real data, consider the behavior of two benchmark indices over a five-year period under a transitioning monetary policy environment:

The S&P U.S. Preferred Stock Index, representing approximately 71% of the preferred stock market traded in the United States, experienced an 18.05% decline during this period. In contrast, the S&P 500, mainly reflecting common stocks, grew by 57.60%.

This divergence illustrates how changes in interest rates impact each category differently. Preferred stocks, generating fixed returns, lose attractiveness when interest rates rise (offering more competitive alternative yields). Common stocks, being more volatile, respond to multiple factors including growth expectations.

Liquidity and Accessibility: Access to Your Money

Common stocks of established companies in major markets offer high liquidity. You can buy and sell quickly, effectively converting your investment into cash.

Preferred stocks are typically less liquid. They have sale restrictions, redemption clauses limiting when you can sell, and secondary markets that are more limited. This lower mobility can make it harder to exit your investment when needed.

Advantages and Limitations by Type

Preferred Stocks:

• Advantages: Predictable dividends often higher than common stocks; greater security in liquidation than ordinary shares; attractive in low-interest-rate environments
• Disadvantages: Limited capital appreciation potential; possible suspension of dividends during financial crises; lack of voting rights; reduced liquidity; complicated redemption clauses

Common Stocks:

• Advantages: High liquidity for quick transactions; significant capital appreciation potential tied to business success; voting rights in corporate decisions
• Disadvantages: Price volatility influenced by company performance and macroeconomic conditions; variable dividends dependent on profitability; risk of total loss in liquidation

How to Get Started: Practical Steps to Invest

If you want to acquire any of these securities, follow this sequence:

1. Choose a Brokerage Platform Find a regulated and established broker that offers access to both types of stocks. Ensure it is reliable and complies with relevant regulations.

2. Set Up Your Account Complete registration with personal and financial information. Most platforms will require an initial deposit.

3. Develop Your Strategy Before executing orders, analyze thoroughly the company whose stocks interest you: its financial figures, sector position, growth prospects.

4. Place the Purchase Order Once on the platform, you have options: “market orders” (at the current price) or “limit orders” (specifying your maximum price). Some brokers also offer additional options such as trading via CFDs (Contracts for Difference), allowing exposure without directly owning the securities.

Investor Profiles: Who Should Choose What

Aggressive investors focused on growth should lean toward common stocks. If your time horizon is long and you tolerate volatility, the potential for significant appreciation justifies taking more risk. These investors are typically in early or mid stages of their financial life, prioritizing capital accumulation.

Conservative investors seeking stability will find preferred stocks their best ally. If you are in the capital preservation phase or approaching retirement, you prefer regular, predictable income. Preferred stocks also work excellently as a diversification tool, balancing the risk of a portfolio dominated by common stocks, combining benefits of relatively fixed income with a variable capital component.

Strategic Recommendations to Optimize Your Portfolio

Balanced Diversification Don’t opt for just one category. Mix common and preferred stocks according to your risk profile, adjusting proportions as your financial situation evolves.

Continuous Monitoring Investments are not “buy and forget.” Review your portfolio periodically, monitor changes in interest rates (which especially affect preferred stocks), and adjust your strategy if the market changes significantly.

Alignment with Personal Goals Your common and preferred stocks should serve specific objectives. Are you seeking long-term growth or short-term income? The answer determines your optimal allocation.

Final Reflection

Understanding common and preferred stocks is not merely academic; it is essential for making informed investment decisions. While preferred stocks offer the promise of stability with fixed rates and payment priority, common stocks open the door to significant appreciation with inherent volatility. Historical experience, reflected in indices like the S&P U.S. Preferred Stock Index versus the S&P 500, shows that both categories respond differently to changing economic contexts. Your success as an investor will depend on aligning your selection between these instruments with your personal financial goals, risk tolerance, and time horizon.