Complete Guide: Common and Preferred Shares in Your Investment Strategy

Fundamental Concepts: Beyond the Basics

When a company decides to raise capital from the market, it typically issues common and preferred shares as the two main pillars of its equity structure. Although both represent ownership in the company, the rights associated with each vary significantly, making them attractive to completely different investor profiles.

Confusion between these two types is common among beginners. However, understanding their characteristics, advantages, and limitations is crucial before committing your capital.

Preferred Shares: Characteristics and Structure

Preferred shares occupy a unique position in the corporate financial hierarchy. They function as a hybrid between traditional equity and debt instruments, combining elements of both worlds.

Nature and Accounting Classification

Although recorded as equity on the company’s balance sheet, preferred shares are often treated as debt by regulatory agencies and rating agencies, especially when they have features such as mandatory redemption or fixed predetermined dividends.

Available Variants in the Market

The market offers multiple varieties of preferred shares tailored to different needs:

• Cumulative: Omitted dividends accumulate for future periods, ensuring eventual payment
• Non-cumulative: Missed dividends do not generate future rights
• Convertible: Allow conversion into common shares under specific conditions
• Redeemable: The company can buy them back at predefined times
• Participating: Dividends are directly linked to the company’s financial results
• With special protection: Include defensive clauses against certain corporate events

Rights and Priorities

Holders of preferred shares enjoy priority in dividend distribution over common shareholders. In liquidation scenarios, they also rank above shareholders, though below creditors and bondholders.

A significant limitation: these shares typically do not grant voting rights at corporate meetings, reducing the investor’s influence on strategic decisions.

Due to their fixed dividends, they are sensitive to fluctuations in interest rates, behaving similarly to traditional bonds in response to macroeconomic changes.

Operational Advantages

• Predictable dividends generally higher than those of common shares
• Greater security in case of company bankruptcy compared to common shares
• Attractive in low-interest-rate environments
• Suitable for diversification strategies

Manifest Disadvantages

• Limited potential for capital appreciation
• Lack of corporate voting rights
• Reduced liquidity with frequent trading restrictions
• Redemption clauses that may limit returns
• Possibility of dividend suspension during financial crises

Common Shares: Dynamism and Volatility

Common shares represent the largest segment of the stock market. They offer direct participation in corporate ownership with active corporate rights.

Types of Common Shares

The structure is not uniform. Some companies issue:

• No-vote shares: Allow participation in profits without decision-making influence
• Multi-class structure: Each category has different voting rights and dividends, enabling specific groups to maintain disproportionate control

Associated Rights

Voting rights are the defining feature. Common shareholders can influence critical decisions such as electing the board of directors and fundamental corporate policies.

In liquidation, their priority is lower than preferred shares, bondholders, and creditors, which poses a significant risk.

Dividends fluctuate according to company performance: prosperous periods generate substantial returns, but recessive times may lead to reductions or suspension of payments.

Competitive Strengths

• High liquidity in main markets, enabling swift transactions
• Significant growth potential linked to business success
• Full corporate rights
• Direct exposure to company profits without limits

Critical Limitations

• Price volatility influenced by macroeconomic factors and corporate performance
• Variable and unpredictable dividends
• Subordinate position in liquidation
• High risk of investment loss

Structured Comparison: Common vs. Preferred Shares

Empirical Perspective: Market Data

Analyzing the relative performance between common and preferred shares yields revealing insights. Considering a five-year horizon:

The S&P U.S. Preferred Stock Index, representing approximately 71% of the U.S. preferred market, experienced a contraction of 18.05%. In contrast, the S&P 500, representing common stocks, increased by 57.60%.

This divergence illustrates how changes in monetary policy and interest rates impact both segments differently: preferred shares face pressure due to their sensitivity to rates, while common stocks benefit from sustained corporate growth.

Entry Routes: How to Start Investing

Step-by-Step Process

1. Select a Platform: Identify a regulated broker with verifiable reputation and competitive commissions

2. Open an Account: Complete the verification process with personal and financial data; make the required initial deposit

3. Conduct Analysis: Research target companies thoroughly: financial statements, sector position, growth prospects

4. Execute Trade: Choose between market orders (immediate execution at current price) or limit orders (at a predefined specific price)

5. Alternative: CFDs: Many brokers offer Contracts for Difference on these shares, allowing exposure without direct ownership, though this mode involves specific risks

Management Principles

• Diversification: Combine both categories to balance risk and return
• Continuous Monitoring: Regularly review positions and adjust strategy according to market evolution

Investor-Instrument Alignment: Optimal Strategies

Aggressive Profile: Common Shares

Investors with high risk tolerance seek long-term capital growth. They have broad time horizons to absorb market fluctuations. Typically, they are in early or intermediate phases of their financial journey, prioritizing wealth expansion over safety.

For these investors, common shares offer optimal exposure to corporate growth and wealth multiplication opportunities.

Conservative Profile: Preferred Shares

Investors in capital preservation phases or nearing retirement require stable and predictable income streams. They value relative safety over accelerated growth prospects.

Preferred shares meet this need by providing reliable dividends, priority in liquidation, and reduced exposure to volatility. They also serve as a diversification tool, balancing fixed and variable income components.

Operational Conclusions

Choosing between common and preferred shares intricately depends on your risk profile, time horizon, and financial goals. Market data confirm that each category behaves distinctly under varying economic conditions.

Common shares remain the main vehicle for long-term capital growth, while preferred shares are solid as a predictable income-generating option for conservative profiles.

A sophisticated strategy combines both, adjusting weights according to personal evolution and macroeconomic conditions. Before any decision, conduct thorough analysis, understand your personal limitations, and if necessary, consult specialized professional advice.

Next Steps:

1. Open your account with a regulated broker
2. Deposit initial capital according to your capacity
3. Start trading with small positions while learning