Common Shares vs Preferred Shares: The Complete Guide for Investors

When a company decides to raise capital through the issuance of shares, not all of them grant the same privileges. Common and preferred shares represent two fundamentally different models of equity participation, each with specific implications for investors. Understanding these differences is crucial before allocating capital in stock markets.

The Nature of Both Instruments

Public companies mainly have two channels to issue shares, differentiated by their rights structure and operational characteristics. Each type responds to diverse strategic objectives for both the company and investors seeking exposure.

Common Shares:

• Represent direct ownership in the company
• Confer voting rights at corporate assemblies
• Generate variable dividends based on financial performance
• In case of insolvency, have lower priority than creditors and preferred shareholders

Preferred Shares:

• Sit between equity and debt in the financial pyramid
• Typically exclude voting rights
• Guarantee dividends at a fixed or predetermined rate
• Provide higher priority in profit distribution and investment recovery in bankruptcy

Deepening into Preferred Shares

These hybrid instruments combine features of both equity and debt obligations, being classified accounting-wise as equity. Their distinctive trait is the issuance of predefined dividends, which, unlike bonds, do not create a legal obligation to return the initial capital.

Available Modalities

The variety of preferred shares allows adaptation to different profiles and strategies:

• Cumulative: unpaid dividends accumulate for future periods
• Non-cumulative: lack rights to overdue dividends
• Convertible: can be transformed into common shares under specified conditions
• Redeemable: the company can buy them back under pre-established conditions
• Participating: their dividends fluctuate with company results
• With protective clauses: include safeguards against specific events

Hierarchical Position and Associated Rights

In the corporate liquidation structure, preferred shareholders are positioned after creditors and bondholders but ahead of common shareholders. Their lack of voting power limits their influence on strategic decisions, although their priority in dividend payments remains unchanged even during financial restrictions.

These titles are sensitive to interest rate changes, behaving similarly to fixed-income instruments. Regulators and rating agencies may reclassify them as debt in specific analytical contexts, especially when they include mandatory redemption or perpetually guaranteed dividends.

Balance of Strengths and Limitations

Advantages:

• Predictable dividends, often higher than common shares
• Greater relative security in liquidation scenarios than common shares
• Attractive during periods of low interest rates

Disadvantages:

• Limited potential for capital appreciation
• Susceptibility to dividend suspension during financial crises
• No voting rights in corporate decisions
• Reduced liquidity, with trading restrictions and redemption clauses

Deepening into Common Shares

They are the most widespread type, representing a portion of corporate ownership with higher volatility but greater growth potential compared to their preferred counterparts.

Structural Variants

Within this universe, there are modalities adapted to specific needs:

• Non-voting shares: grant participation in profits without management influence
• Multi-class structures: each category has different voting rights and dividend distributions, allowing certain groups to maintain significant control with less shareholding

Rights and Prerogatives

The main distinction is the voting right at assemblies, enabling investors to influence relevant issues such as the appointment of directors. In liquidations, their claim on assets is subordinate to creditors, bondholders, and preferred shareholders. Their dividends depend on corporate profitability, allowing high gains in expansion cycles but also total absence of distributions during slowdowns.

Analysis of Advantages and Risks

Advantages:

• High liquidity, facilitating swift operations in main markets
• Significant potential for capital appreciation linked to corporate growth
• Ability to influence corporate direction

Disadvantages:

• Price volatility determined by company performance and macroeconomic conditions
• Inconsistent dividends, susceptible to reduction or elimination depending on business cycles
• Risk of capital loss in cases of corporate deterioration

Comparative Matrix

Acquisition Methodology

Initial Stage - Platform Selection: Identify regulated and reliable intermediaries that facilitate access to these instruments.

Second Stage - Account Activation: Complete registration with personal and financial data; make an initial deposit according to platform requirements.

Third Stage - Strategic Definition: Conduct thorough analysis of target companies: evaluate financial metrics, sector positioning, growth prospects.

Fourth Stage - Operational Execution: Through the platform, choose between market orders (at current price) or limit orders (at the price set by the investor).

Alternatively, it is possible to operate via CFDs (Contracts for Difference) on these shares, without physical ownership, depending on platform availability and market liquidity.

Strategic Guidelines:

• Incorporate both common and preferred shares into the portfolio for risk mitigation
• Conduct periodic monitoring and adjust positioning in response to changing contexts

Selection According to Investor Profile

High-Risk Investors: Common shares are suitable for those with the capacity and willingness to assume short-term fluctuations, seeking significant capital accumulation. Particularly appropriate in early or intermediate stages of financial trajectories, where the time horizon is long and objectives prioritize growth over immediate income.

Conservative Profile Investors: Preferred shares align with strategies of wealth preservation and predictable income generation. Often chosen by individuals close to retirement or in asset monetization phases, valuing cash flow stability and risk exposure mitigation. They also serve as diversification tools, balancing portfolios through a combination of fixed and variable income features.

Concluding Reflection: Relative Market Behavior

A revealing analysis arises from contrasting the S&P U.S. Preferred Stock Index against the S&P 500. The former, representing approximately 71% of the U.S. preferred market, is a sectoral benchmark. Over the recent five-year period, while the S&P 500 expanded by 57.60%, the preferred index contracted by 18.05%. This divergence underscores the different nature of both instruments in response to monetary policy changes: while common shares capture appreciation during economic expansion cycles, preferred shares show greater vulnerability to interest rate hikes that erode their fixed dividends.

Both modalities maintain operational legitimacy depending on macroeconomic context and investor profile, with the conscious selection between common and preferred shares being key to optimizing investment results.

Initial Steps to Get Started

1. Platform Registration
2. Account Funding
3. Begin Operations