Distinguishing between preferred shares and ordinary shares is crucial for investors looking to navigate the complexities of the stock market. While both represent ownership in a company, they carry distinct rights and privileges. Preferred shares typically offer fixed dividends and priority in asset distribution during liquidation, making them more akin to debt securities than traditional equity. In contrast, ordinary shares confer voting rights and potential for higher returns through dividends and capital appreciation.
What Are Ordinary Shares?
Ordinary shares, also known as common shares, are the primary type of equity issued by companies. When investors buy ordinary shares, they become part-owners of the company and gain the right to vote on major corporate decisions, such as electing the board of directors and approving mergers or acquisitions. These shares represent a residual claim on the company’s assets, meaning shareholders are last in line to receive any remaining assets in the event of liquidation, after all debts and obligations have been satisfied.
Another critical aspect of ordinary shares is their potential for capital growth. Shareholders can benefit from the appreciation of share prices over time, which is directly tied to the company’s performance and market conditions. Dividends on ordinary shares are not fixed and can vary significantly, depending on the company’s profitability. While this means that shareholders can enjoy substantial returns during good times, it also implies higher risk, as dividends can be reduced or omitted if the company faces financial difficulties.
What Are Preferred Shares?
Preferred shares are a special class of equity that provides shareholders with certain advantages over ordinary shareholders. One of the key features of preferred shares is their fixed dividend payments, which are typically higher and more predictable than those of ordinary shares. These dividends are often cumulative, meaning if a company misses a dividend payment, it must pay it in the future before any dividends can be paid to ordinary shareholders. Preferred shares also usually come with a par value, which is the amount the shareholder would receive in the event of the company’s liquidation, giving them a higher claim on assets than ordinary shareholders.
Rights of Preferred Shareholders
While preferred shareholders enjoy certain financial advantages, they often lack some of the rights that ordinary shareholders have. Most notably, preferred shareholders usually do not have voting rights, meaning they have no say in corporate governance or major company decisions. However, in some cases, if the company fails to pay dividends for a certain period, preferred shareholders may gain voting rights. Additionally, in the event of liquidation, preferred shareholders have a priority claim over the company’s assets, after debt holders but before ordinary shareholders, making their investment slightly less risky. This combination of steady income and lower risk makes preferred shares an attractive option for conservative investors seeking stability.
Key Differences Between Ordinary and Preferred Shares
| Aspect | Ordinary Shares | Preferred Shares |
| Voting Rights | Typically have voting rights in company decisions | Usually no voting rights |
| Dividend Payments | Variable, based on company profits | Fixed, often higher than ordinary share dividends |
| Claim on Assets | Last in line during liquidation | Priority over ordinary shares in asset claims |
Understanding the key differences between ordinary and preferred shares is essential for making informed investment decisions. Here are the main distinctions:
- Voting Rights
- Ordinary Shares: Shareholders typically have the right to vote on important company matters, such as the election of the board of directors and significant corporate policies. This gives ordinary shareholders a say in the direction of the company.
- Preferred Shares: Generally, preferred shareholders do not have voting rights. This means they cannot influence company decisions, which might be a drawback for those looking for a more active role in the company’s governance.
- Dividend Payments
- Ordinary Shares: Dividends are not guaranteed and can fluctuate based on the company’s profitability and discretion. This variability can result in higher dividends during profitable times but also means there may be no dividends during leaner periods.
- Preferred Shares: Dividends are usually fixed and paid out at regular intervals, providing a more stable and predictable income stream. Preferred dividends are often higher than those of ordinary shares, making them attractive to income-focused investors.
- Claim on Assets
- Ordinary Shares: In the event of liquidation, ordinary shareholders have the last claim on the company’s assets. After all debts, liabilities, and preferred shareholders have been paid, ordinary shareholders may receive any remaining assets, which often means they get nothing if the company is deeply insolvent.
- Preferred Shares: Preferred shareholders have a higher claim on assets than ordinary shareholders. In a liquidation scenario, they are paid out before ordinary shareholders but after debt holders, providing a level of protection in adverse situations.
These distinctions highlight the different roles and benefits that ordinary and preferred shares play in an investment portfolio. While ordinary shares offer greater potential for capital appreciation and a say in company decisions, they come with higher risk and less predictable income.
Advantages of Ordinary Shares
Ordinary shares come with several advantages that can make them an attractive investment choice for many investors. These benefits primarily revolve around the potential for high returns and the influence shareholders can exert on company decisions.
- Potential for Higher Returns
- Capital Appreciation: Ordinary shares have the potential for significant capital growth. As the company grows and becomes more profitable, the value of its shares can increase substantially, offering high returns on investment.
- Dividends: Although variable, dividends from ordinary shares can be quite substantial during profitable years. This means that investors can enjoy both capital gains and income from their investment.
- Voting Power
- Influence on Company Decisions: Ordinary shareholders typically have voting rights that allow them to participate in major company decisions. This includes electing the board of directors and voting on important corporate policies.
- Corporate Governance: By having a say in how the company is run, ordinary shareholders can influence corporate governance and strategic direction, ensuring the company is managed in a way that aligns with their interests.
The potential for higher returns and voting power makes ordinary shares particularly appealing to investors looking for growth and a say in the company’s future. However, these advantages come with a trade-off in terms of higher risk and less predictable income compared to preferred shares.
Advantages of Preferred Shares
Preferred shares offer distinct advantages that cater to investors seeking stable income and lower risk. These benefits revolve around predictable dividend payments and a higher claim on company assets.
- Fixed Dividends
- Predictable Income: One of the main attractions of preferred shares is the fixed dividend payments. These payments are typically set at a predetermined rate and paid out at regular intervals, providing a reliable income stream for investors.
- Higher Dividend Rates: Preferred shares often come with higher dividend rates compared to ordinary shares. This makes them particularly attractive to income-focused investors looking for steady returns.
- Lower Risk
- Priority on Assets: In the event of a company’s liquidation, preferred shareholders have a higher claim on the company’s assets than ordinary shareholders. This means that in adverse financial situations, preferred shareholders are more likely to recoup their investment.
- Dividend Priority: Preferred shareholders receive their dividends before ordinary shareholders. If the company has limited funds for dividends, preferred shareholders are prioritized, reducing the risk of missing out on dividend payments.
These advantages make preferred shares an appealing option for conservative investors who prioritize stable income and lower risk. While preferred shares do not offer the same potential for capital appreciation as ordinary shares, their fixed dividends and asset priority provide a more secure investment vehicle.