How to choose between preferred and common stocks: a guide for investors

When discussing equity participation, not all securities are the same. Publicly traded companies can issue multiple categories of shares, each with different characteristics and benefits. Voting rights, dividend priority, and treatment in case of insolvency vary significantly depending on the type of share. For those looking to build a solid portfolio, understanding how preferred and common shares differ is essential.

Two main categories: essential features

The stock market is primarily organized around two structures: common shares and preferred shares. Although both represent ownership in a company, their attributes and benefits diverge considerably.

Common shares: They are the most widespread security in markets. They allow owners to participate in corporate decisions through voting at shareholder meetings. Income generated varies according to the company’s financial performance, meaning dividends can be substantial in prosperous years or minimal during weak economic cycles. In the event of bankruptcy, these shareholders recover capital only after all debts and claims of preferred shareholders have been satisfied.

Preferred shares: These are positioned at an intermediate level between pure equity investment and debt instruments. They do not confer voting power in corporate decisions. However, they guarantee more consistent returns through dividends that are generally fixed at a pre-established rate. In liquidation situations, holders of these securities have priority over common shareholders to recover their investment, although they remain subordinate to traditional creditors.

Types of preferred shares available

The spectrum of preferred shares is varied, adapting to different corporate financing and investment needs:

Cumulative: Unpaid dividends accumulate over periods, ensuring the investor eventually receives the full owed payments.

Non-cumulative: No right to collect overdue dividends if the company omitted payment in any period.

Convertible: Allow transforming the preferred share into a common share under certain predefined scenarios, providing strategic flexibility.

Redeemable: The issuing company can buy back these securities under specified conditions and timeframes, limiting indefinite holding.

Participating: Dividends are directly linked to the company’s financial performance, combining partial stability with potential upside.

With protective clauses: Include specific guarantees against critical corporate events, safeguarding the investor’s interests.

Rights structure: preferred shares

Strategically positioned in the hierarchy of corporate claims, preferred shares grant tangible benefits to their holders. In liquidation processes, they rank ahead of common shareholders but are subordinate to financial institutions and bondholders.

Most of these shares do not confer voting rights, although variants with multiple or conditional votes exist. This restriction means investors have less influence over board appointments or major strategic decisions.

A distinctive feature is sensitivity to interest rate movements. Since they offer fixed returns, when market rates rise, the relative attractiveness of these securities decreases (and vice versa), behaving similarly to bonds.

Regarding income payments, preferred shareholders are protected: they receive dividends before common shareholders. This priority is especially relevant when corporate profitability is limited. Some variants ensure accumulation of missed payments, guaranteeing future compensation.

Rights structure: common shares

Common shares give their owners direct influence over corporate affairs. Voting at meetings is a power instrument, allowing participation in critical decisions such as selecting executive leadership and approving strategic policies.

In liquidation scenarios, these shareholders are last in line, after debt holders, bondholders, and preferred shareholders. However, if the company is successful and generates significant assets after satisfying prior obligations, common shareholders can recover substantial amounts.

Dividends on common shares fluctuate directly with business results. During periods of growth and strong profitability, payments can be generous. During economic slowdowns or weak operational performance, payments decrease or are suspended entirely.

Comparative analysis: profitability versus security

Preferred shares: They offer predictable income, typically higher than common shares, making them attractive in low-interest environments. The security against insolvency is greater than that of common shares but lower than bonds. However, capital appreciation potential is limited. Dividends can be interrupted during severe financial crises, and low liquidity (with sale restrictions and corporate redemption options) can make quick exits difficult.

Common shares: They are characterized by high liquidity in main markets, enabling quick buying and selling. Appreciation potential is considerable, directly linked to corporate growth and macroeconomic conditions. However, volatility is significant. Prices fluctuate based on company performance and market sentiment. Dividends, being variable, can be reduced or null during low performance phases.

Historical performance data: S&P Preferred vs S&P 500

The comparison between the S&P U.S. Preferred Stock Index and the S&P 500 clearly illustrates the different dynamics of these investment types. The preferred stock index accounts for approximately 71% of the U.S. market in this segment, demonstrating its magnitude in the market structure.

Over a recent five-year period, performance diverged markedly. While the S&P 500 advanced 57.60%, driven by technology growth and business dynamism, the S&P U.S. Preferred Stock Index declined 18.05%. This divergence reflects the impact of monetary policy changes: when central banks raise interest rates to combat inflation, fixed-yield securities become less attractive, pushing the preferred index downward. Simultaneously, robust company common stocks can thrive in subsequent economic recoveries.

Selection based on investor profile

Dynamic investor: Tolerates volatility and has an extended time horizon (10+ years). Their goal is to maximize wealth growth. This profile seeks common shares, leveraging long-term appreciation potential and the ability to influence corporate decisions. Typically, they are in early or mid stages of their financial journey.

Conservative investor: Prioritizes stability and regular income flows over spectacular growth. Often in capital preservation phases or approaching retirement. This profile leans toward preferred shares, which offer predictable returns, lower exposure to volatility, and priority in liquidation. They also use these shares for diversification, balancing fixed income and equity components.

Practical steps to participate

1. Select platform: Choose a regulated broker with a good reputation and competitive offerings of common and preferred shares.

2. Open account: Complete personal and financial data forms, making the initial deposit according to requirements.

3. Analyze objectives: Evaluate the types of preferred and common shares that align with your risk tolerance and time horizon.

4. Execute orders: Use market order options (current price) or limit order (specific price). Some brokers allow trading via CFDs without directly owning the securities.

5. Diversify: Combine common and preferred shares in proportions adjusted to your profile, reducing concentrated risk.

6. Continuous monitoring: Periodically review your positions and adjust your strategy as the market and your circumstances evolve.

Conclusion: understanding the stock market

Preferred and common shares coexist in markets as tools with different purposes. The recent evolution of the S&P U.S. Preferred Stock Index (18.05% decline over five years versus the 57.60% rise of the S&P 500) underscores how economic cycles and monetary policy changes impact each category differently.

Choosing one or the other depends on your financial situation, objectives, and risk aversion. There is no “correct” universal option; the optimal decision is one aligned with your personal profile. Many sophisticated investors combine both in balanced portfolios, capturing benefits of stability and growth simultaneously.