Common Stocks vs. Preferred Stocks: A Guide for Investors

When discussing stock market investments, it is crucial to understand that common and preferred shares do not operate in the same way. Public companies issue various types of shares, each with a unique set of characteristics and rights. The fundamental difference lies in how profits are distributed, decision-making power, and priority in critical events such as liquidations.

For those wishing to venture into the stock markets, knowing how to differentiate between both classes is essential. This guide breaks down the specifics of each and how to align them with your investor profile.

The Nature of Shares: Two Different Worlds

Common shares represent partial ownership in a company and come with significant rights. Their holders can participate in corporate decisions through voting at shareholder meetings and have the right to receive dividends when the company makes profits. However, these dividends are not guaranteed or fixed; they fluctuate based on financial performance.

Preferred shares, on the other hand, occupy an intermediate position in the corporate capital structure, between pure equity and debt. Although they do not grant voting rights, they offer something more valuable for certain investors: predetermined dividends and a priority position in the payment chain. In case the company faces financial difficulties, preferred shareholders receive compensation before common shareholders.

Key Features Defining Each Type

###Structure and Rights

Common shares allow their holders to directly influence corporate management. This voting right is fundamental for those seeking not only economic returns but also participation in strategic decisions.

Preferred shares, in contrast, sacrifice this corporate influence in exchange for financial security. Although they lack voting power, they guarantee a more predictable income flow through established dividends, whether fixed or with a pre-set rate.

###Dividends: Variability vs. Predictability

In common shares, dividends depend entirely on the company’s operating results. A prosperous year may mean generous payments; a crisis year may result in no payments or drastic reductions. This creates volatility but also opportunities for exponential growth during expansion periods.

Preferred shareholders enjoy greater stability. There are various modalities: cumulative dividends, where missed payments are recovered in subsequent periods; non-cumulative dividends, which are simply not paid; and participating dividends, linked to financial performance but with a guaranteed minimum.

###Priority in Liquidation

The payment hierarchy is critical in scenarios of corporate crisis. If a company goes bankrupt, the order of compensation is: first creditors and bondholders, then preferred shareholders, and finally common shareholders. This means that investors in common shares face a higher risk of losing their investment.

Specialized Types of Preferred Shares

Within the universe of preferred shares, there are sophisticated variants designed for specific strategies:

Redeemable shares: The company can buy them back under certain conditions, providing corporate flexibility but reducing investor certainty about the duration of their investment.

Convertible shares: Allow transformation into common shares under predefined circumstances, combining initial stability with appreciation potential.

Shares with special protections: Include clauses that protect the investor against specific events, such as changes in interest rates or modifications in the capital structure.

Strengths and Weaknesses of Each Modality

###Common Shares: Potential vs. Risk

Advantages:

• High liquidity in established markets, enabling quick buying and selling
• Significant capital appreciation potential linked to business growth
• Voting rights in key corporate decisions

Disadvantages:

• Price volatility influenced by macroeconomic and market factors
• Uncertain and variable dividends
• Lower priority in corporate liquidations
• Greater exposure to systematic market risk

###Preferred Shares: Security vs. Limitations

Advantages:

• Higher and more predictable dividends compared to common shares
• Greater relative security in case of company liquidation
• Attractive in low-interest-rate environments
• Reduce overall portfolio volatility

Disadvantages:

• Limited potential for capital growth
• No voting rights
• Lower liquidity and restrictions on sale
• Vulnerability to changes in monetary policies (sensitivity to interest rates)
• Possibility of dividend suspension in severe financial crises

Structured Comparison

Practical Access: How to Start Investing

The process to invest in either of these instruments follows relatively simple steps:

Choose a regulated platform: Ensure the broker is authorized and offers access to the instruments you seek.

Complete registration: Provide personal and financial information; make an initial deposit according to your possibilities.

Develop your analysis: Study the company’s financials, sector, growth prospects, and dividend policy.

Execute your trade: From the broker’s platform, you can place market orders or set customized limit prices.

Consider derivative alternatives: Some brokers allow trading via CFDs (Contracts for Difference) on these shares, offering flexibility without physical possession, though with additional risk considerations.

A fundamental recommendation is to diversify by combining both classes in proportions that reflect your risk tolerance. Periodically review your portfolio and adjust according to changes in your objectives or market conditions.

Strategies According to Investor Profile

Aggressive investors seek accelerated growth of their wealth. For them, common shares represent the natural choice: they accept short-term fluctuations in exchange for potential long-term appreciation. This profile is typical of individuals in early or mid-stages of their financial life, with an extended time horizon.

Conservative investors prioritize capital preservation and regular income flows, often near retirement or approaching it. Preferred shares align perfectly with this goal: they offer stable returns without the volatility of common stocks.

A balanced strategy combines both, leveraging their complementary features: the stability of preferred shares to fund current expenses and the potential appreciation of common shares for long-term growth.

Macro Perspective: Sectoral Behavior

To deepen understanding of how these investments behave in real contexts, consider the S&P U.S. Preferred Stock Index versus the S&P 500. This preferred index represents approximately 71% of the traded preferred stock market in the United States, providing a representative view.

In a recent five-year period, the S&P U.S. Preferred Stock Index declined by 18.05%, while the S&P 500 increased by 57.60%. This dramatic divergence illustrates how these instruments respond oppositely to monetary policy changes: when central banks raise interest rates, fixed dividends of preferred shares become less attractive relatively, pressuring their prices. Simultaneously, the rate hikes can stimulate certain sectors reflected in the S&P 500.

This dynamic underscores the importance of understanding not only what common and preferred shares are but also how their performance intertwines with economic cycles and global monetary policies.

Final Reflection

Choosing between common and preferred shares is not binary but a matter of alignment with personal financial goals. While common shares offer an entry point into corporate economic growth through voting rights and capital appreciation, preferred shares bridge the gap between conservative fixed-income investments and equity participation, offering relative security without entirely abandoning return potential.

Knowing these essential distinctions allows for building resilient portfolios tailored to each stage of the investor’s financial life.