Choosing Between Common and Preferred Stocks: What Every Investor Should Know

When we start in the world of stock market investments, one of the first points of confusion is understanding that common shares are not the only option. Companies can issue multiple categories of equity securities, each with different characteristics and rights. To make informed decisions, you need to understand how these modalities work and which one best suits your risk profile.

The Two Main Categories of Equity Securities

When a company goes public, it generally offers two main types of equity participation. Although they share the nature of representing corporate ownership, their operational characteristics differ substantially.

Ordinary (or common) shares are the most traditional and well-known securities. They grant the holder voting rights at corporate meetings, allowing influence over strategic decisions. Their dividends fluctuate according to business profitability, implying variability in income but also potential for significant growth.

Preferred shares, on the other hand, function as a hybrid between equity and debt instruments. They offer predetermined or fixed dividends, prioritized over payments to ordinary shareholders. However, they typically lack voting rights, limiting participation in corporate management.

Deepening into Preferred Shares: Characteristics and Variants

Preferred shares occupy a particular place in the corporate financial structure. Accounting-wise, they are classified as equity, but in regulatory analysis, they can be treated as debt due to their similarity to bonds in key aspects.

A notable feature is the issuance of dividends at a preset rate. Unlike traditional debt instruments, these dividends do not create a legal obligation for capital repayment but do offer greater certainty than dividends from ordinary shares.

There are various modalities within this category:

• Cumulative: unpaid dividends accumulate for future periods, ensuring subsequent compensation
• Non-cumulative: do not carry rights to overdue dividends
• Convertible: can be transformed into ordinary shares under specific conditions
• Redeemable: the company can buy them back at a predetermined price
• Participating: link dividends directly to financial results
• With protective clauses: include protections against specific corporate events

Rights and Privileges of Preferred Shareholders

In the hierarchy of corporate claims, holders of preferred shares are positioned between common shareholders and creditors. In case of company liquidation, they have priority over common shareholders, although they are subordinate to bondholders and general creditors.

Sensitivity to interest rate changes is another important characteristic. Since their dividends are fixed, variations in the interest rate environment directly affect their relative attractiveness.

Key advantages of this investment type:

• More predictable dividends, usually higher than ordinary shares
• Greater security in liquidation than ordinary shares
• Attractive in low-interest-rate environments
• Lower price volatility

Disadvantages to consider:

• Limited potential for capital appreciation
• No voting rights
• Liquidity generally restricted
• Dividends may be suspended during financial crises
• Redemption clauses that limit flexibility

Exploring Common Shares: Greater Potential, Greater Risk

Common shares represent the most common form of equity participation. They give the investor a real ownership stake in the company, with inherent rights associated with that condition.

The voting right at shareholder meetings is perhaps the most significant. It allows influence over crucial decisions such as the election of directors and corporate strategy. However, there are interesting variants in this area: some companies issue non-voting shares, while others implement multiple class structures with differentiated rights.

Dividends from common shares are variable and directly correlated with business performance. During successful periods, they can be substantial. In times of uncertainty, they may be reduced or eliminated entirely.

Regarding liquidation, ordinary shareholders recover assets only after claims from creditors, bondholders, and preferred shareholders are satisfied.

Main advantages:

• Potentially high liquidity in major markets
• Significant capital appreciation linked to business growth
• Voting rights and participation in corporate decisions
• Long-term capital growth in successful companies

Major disadvantages:

• Price volatility influenced by multiple factors
• Risk of capital loss
• Unpredictable and variable dividends
• Last in priority during liquidations
• Sensitivity to economic cycles and market sentiment

Direct Comparison: Difference Table

Purchase Strategy: Practical Steps

If you decide to invest in this class of securities, the process follows a clear structure:

1. Select a regulated platform: Choose a broker with proper licenses and verified track record
2. Open an account: Complete identification procedures and initial deposit
3. Business analysis: Study financial indicators, sectors, growth prospects
4. Execute the operation: Use market orders (current price) or limit orders (specific price)
5. Alternative: CFDs: Consider trading Contracts for Difference on these securities, without physically owning them

Operational recommendations:

• Diversify by combining both modalities according to your time horizon
• Regularly review your portfolio and adjust based on market changes
• Adjust the proportion of each type according to your risk tolerance

Investor Profiles: Who Each Option Suits

For aggressive investors: Common shares are attractive. These individuals, usually in early stages of their financial life, can tolerate significant fluctuations in exchange for exponential long-term growth potential. The broad time horizon allows them to overcome cyclical volatilities.

For conservative investors: Preferred shares better align with capital preservation goals. Typically in advanced stages or nearing retirement, these investors prioritize a steady income stream over speculative opportunities. They seek to reduce risk exposure while maintaining returns higher than pure fixed-income instruments.

Mixed strategy: Many sophisticated investors combine both categories. This allows balancing growth pursuit with the need for predictable income, dynamically adjusting according to economic cycles.

Market Analysis: Comparative Behavior

Comparing market indices provides perspective on behavioral differences. The S&P U.S. Preferred Stock Index, representing approximately 71% of the preferred stock market traded in the United States, offers a valuable benchmark.

In a recent five-year period, while the S&P 500 increased by 57.60%, the S&P U.S. Preferred Stock Index declined by 18.05%. This disparity highlights how changing monetary policy environments affect these categories differently. The tightening of interest rates negatively impacted preferred stocks (sensitive to rates), while benefiting overall corporate profitability.

This contrast illustrates why choosing between categories is not trivial: it depends on the anticipated macroeconomic environment and the investor’s specific objectives.

Conclusion: Choosing Your Investment Path

There is no universally superior option between common and preferred shares. The choice depends on your personal financial situation, time horizon, risk tolerance, and return objectives.

Common shares offer transformational potential for those who can wait, while preferred shares provide stability for those needing predictable income. Many successful investors combine both, adjusting proportions according to the evolution of their circumstances and market conditions.

The first step is to genuinely understand the characteristics of each option, not just follow trends. With that knowledge, you can build an equity strategy that truly aligns with your financial goals.