Common and Preferred Shares: A Complete Guide to Their Fundamental Differences

Why It Matters to Know the Differences Between Common and Preferred Shares

When a company decides to raise capital in the markets, not all securities it issues are the same. The distinction between common and preferred shares is crucial for anyone looking to build a solid investment portfolio. Each type of share represents a different agreement between the investor and the company: while some seek corporate influence and exponential growth, others prioritize predictable income streams and security. Understanding these differences allows you to align your investment decisions with your actual financial goals.

Quick Comparison: Common vs. Preferred Shares

Detailed Analysis: Preferred Shares

Hybrid Nature of Preferred Shares

Preferred shares occupy a peculiar position in the corporate financial structure. They are accounted for as equity but combine attributes of both debt instruments and capital. Their distinctive feature is that they generate dividends with a fixed or predetermined rate, although, unlike traditional bonds, they do not legally obligate the company to repay the invested capital.

Main Categories of Preferred Shares

Companies design specific variants according to their financing needs:

• Cumulative Shares: Unpaid dividends accumulate, ensuring payment in future periods
• Non-Cumulative Shares: Only generate rights to dividends for the current period; missed dividends are lost
• Convertible Shares: Can be transformed into common shares under pre-established conditions
• Redeemable Shares: The company can buy them back at specified dates
• Participating Shares: Dividends are directly linked to the company’s financial results
• Shares with Special Protections: Include clauses that protect the investor against specific corporate events

Rights and Privileges of Preferred Shareholders

Although they lack voting power in assemblies, holders of preferred shares enjoy significant benefits:

In case of bankruptcy or liquidation, these shareholders occupy an intermediate position: they are ahead of common shareholders but behind creditors and bondholders. This offers greater security than common shares, though less than debt instruments.

Regarding dividends, preferred shareholders receive priority payments. If the company faces financial constraints, their dividends are paid before those of common shares. In cumulative variants, the retroactive payment of missed dividends is guaranteed.

Sensitivity to changes in interest rates is another relevant trait. Since their dividends are fixed, when interest rates rise in the economy, the relative attractiveness of these shares decreases, affecting their market value.

Advantages and Limitations of Investing in Preferred Shares

Advantages:

• Higher and more stable dividends than common shares
• Greater security in corporate liquidation events
• Protection in low-interest-rate environments
• Cumulative feature in many variants

Disadvantages:

• Lack of voting rights, limiting corporate influence
• Restricted capital appreciation potential
• Limited liquidity, with frequent sale restrictions
• Risk of dividend suspension in financial crises
• Redemption clauses that may force buybacks at unfavorable prices

Common Shares: Growth Engine of Equity

Essence of Common Shares

Common shares represent the most widespread form of equity participation. Each share symbolizes a fraction of the company’s ownership, giving the investor exposure to growth and responsibility for operational risks. Unlike preferred shares, these shares promise a higher potential for appreciation, albeit with significant volatility.

Variants of Common Shares

Modern capital structures have generated subcategories:

• Non-Voting Shares: Some issuers create these to allow profit participation without ceding control
• Multiple Class Shares: Different classes have varying voting rights and dividend policies, allowing certain groups to maintain disproportionate control

Fundamental Rights of Ordinary Shareholders

Voting power is the most prominent privilege. Ordinary shareholders participate in shareholder meetings, influencing critical decisions such as electing directors and strategic policies.

In liquidation, these shareholders are in the last position of claim: only after creditors, bondholders, and preferred shareholders are paid. This higher-risk position is compensated with the potential for higher returns in successful companies.

Dividends fluctuate according to financial performance. Profitable companies may distribute generous earnings, while during uncertain periods, dividends can be significantly reduced or eliminated.

Advantages and Risks of Common Shares

Advantages:

• High liquidity in main markets, enabling quick transactions
• Considerable potential for long-term capital appreciation
• Voting rights in corporate decisions
• Direct exposure to corporate and economic growth

Risks:

• Significant price volatility influenced by company performance and market conditions
• Variable and unpredictable dividends
• Last position in liquidations, increasing total loss risk
• Dependence on macroeconomic factors and market sentiment

Market Evidence: Comparative Performance of Both Classes

A revealing analysis comes from comparing the S&P U.S. Preferred Stock Index against the S&P 500 over a five-year horizon. The S&P U.S. Preferred Stock Index, representing approximately 71% of the traded preferred stock market in the United States, experienced an 18.05% decline, while the S&P 500 increased by 57.60%.

This dramatic gap illustrates the fundamental differences: during periods of significant monetary policy changes, preferred shares (sensitive to interest rates) suffer, while common shares can benefit from economic growth. This divergent behavior underscores the importance of choosing the share class aligned with your market expectations and risk profile.

Investment Strategy According to Your Profile

For Aggressive Investors: Common Shares

Investors with a high-risk profile and an extended time horizon should consider common shares as the core of their portfolio. These participants, typically in early or mid stages of their productive life, seek to maximize wealth growth. The ability to withstand short-term volatility is offset by the possibility of significant long-term capital accumulation. The voting right also allows these investors to actively influence corporate governance.

For Conservative Investors: Preferred Shares

Investors prioritizing capital preservation and regular income find preferred shares a more suitable vehicle. Typically, these participants are in advanced stages of their financial life or nearing retirement. Predictable dividends offer stable cash flows, while liquidation priority provides psychological peace of mind. Additionally, preferred shares serve as a diversification tool: their hybrid characteristics create a different correlation compared to common shares, improving the risk-return balance.

How to Acquire Common and Preferred Shares: Step-by-Step Procedure

Step 1 - Choose a Reliable Intermediary
Select a regulated brokerage platform with a solid reputation. Ensure it offers access to both share classes and complies with safety and regulatory transparency standards.

Step 2 - Set Up Your Investment Account
Complete the account opening form providing personal data, financial information, and defining your risk profile. Make the initial deposit required by the platform.

Step 3 - Research and Define Your Strategy
Deeply analyze the companies you consider investing in. Review financial statements, competitive position, sector outlook, and historical dividend policies. Decide whether your goal is growth (favoring common shares) or income (favoring preferred shares).

Step 4 - Execute Purchase Orders
Through your broker’s platform, you have two options: “market orders” (immediate purchase at current price) or “limit orders” (buy only if the price falls to your specified level). You can also trade via CFDs (Contracts for Difference) on these shares, though this depends on the broker’s offerings and available liquidity.

Step 5 - Monitor and Periodically Adjust
Regularly review your portfolio. When the market changes significantly or your personal circumstances shift, adjust your allocation between both share classes.

Key Recommendations to Maximize Your Investment

Integrated Diversification: Do not concentrate your capital in just one class. Combining common and preferred shares reduces overall risks while maintaining exposure to growth. A balanced portfolio typically reduces volatility without sacrificing performance significantly.

Alignment with Objectives: Select the proportion of each class according to your time horizon, current income needs, and psychological tolerance for fluctuations. Young investors should favor common shares; near-retirees, preferred shares.

Continuous Review: Changes in monetary policy, economic cycles, and corporate situations require strategic adjustments. Do not assume a static position indefinitely.

Conclusion: Understanding the Dynamics of the Stock Market

The distinction between common and preferred shares is not merely academic: it represents the fundamental choice between radically different investment strategies. As recent data shows, where the S&P U.S. Preferred Stock Index fell 18.05% while the S&P 500 rose 57.60% over five years, the behavior of both classes diverges significantly under different economic conditions.

Recognizing that the S&P U.S. Preferred Stock Index accounts for 71% of the U.S. preferred stock market provides perspective on the scale of this segment. The smart choice between common and preferred shares depends on your personal financial situation, short- and long-term goals, and ability to tolerate volatility. Regardless of your preference, diversification between both classes offers the best protection against future market uncertainties.