How to Differentiate Preferred and Common Stocks in Your Investment Strategy

Publicly traded companies utilize two main mechanisms to raise investment: issuing preferred shares and common shares. Although both represent equity participation, their characteristics, rights, and risks are completely different. For those looking to build a solid portfolio, this distinction is fundamental.

Comparative Chart: The Essentials of Each Type

Before diving deeper, here is the direct contrast:

Common Shares: The Vehicle of Growth

Common shares are the most widespread instrument in stock markets. They represent a portion of company ownership without special limitations on voting rights.

Distinctive Features

Holders of common shares participate in shareholder meetings with decision-making power. They can influence the appointment of boards of directors and corporate strategic lines. This political prerogative is exclusive to this type of equity.

Regarding compensation, dividends fluctuate based on financial performance. During prosperous periods, they can be generous; in turbulent times, they decrease or disappear entirely. This volatile nature directly reflects the company’s health.

In insolvency contexts, common shareholders are last in line for claims, behind creditors, bondholders, and preferred shareholders.

Advantages for the Investor

• Capital appreciation: Tied to corporate growth and business success
• High liquidity: Enables quick transactions on regulated platforms
• Decision-making power: Real influence in corporate governance
• Access to multiple variants: Different classes with differentiated rights available

Disadvantages to Consider

• Inherent volatility: Prices fluctuate due to market conditions and performance
• Uncertainty in dividends: No guarantee of periodic payments
• Risk of loss: In bankruptcy, they are last to recover investment
• Requires constant analysis: Needs monitoring and strategic adjustments

Preferred Shares: The Option for Stable Yield

Preferred shares occupy an intermediate position between pure equity and financial debt. They combine elements of both worlds, providing unique hybrid features.

Nature and Structure

Accounting-wise, they are recorded as equity, but behaviorally resemble fixed-income instruments. The issuer establishes a predefined dividend paid before any distribution to common shareholders. This preference is their hallmark.

Unlike traditional debt, there is no legal obligation to reimburse the invested capital. The company can keep these shares outstanding indefinitely, although rescue clauses are often included.

Available Variants

Cumulative shares: Missed dividends during tough periods accumulate and must be paid when financial conditions improve.

Non-cumulative shares: Missed dividends are forfeited without right to future compensation.

Convertible shares: Can be transformed into common shares under predetermined conditions, offering upside potential.

Redeemable shares: The company retains the option to buy back, limiting the investor’s long-term exposure.

Participative shares: Dividends are linked to actual results, combining stability with opportunities for additional gains.

Advantages for the Investor

• Predictable income: Dividends generally higher than current interest rates
• Greater security: Priority over common shares in liquidation
• Consistent returns: Less volatile than common shares
• Diversification tool: Balances risk in mixed portfolios

Disadvantages to Evaluate

• No corporate voting rights: Lack of voting rights limits influence
• Limited growth potential: Appreciation potential is very small
• Suspension of payments: Dividends can be interrupted during crises
• Restricted liquidity: Less active secondary markets, rescue clauses complicate exit

Sensitivity to Interest Rates

A critical aspect: preferred shares react strongly to changes in interest rates. If central banks raise rates, these shares lose relative attractiveness (their fixed dividends become less competitive compared to more profitable instruments). The opposite occurs in low-rate environments.

Common shares, lacking fixed cash flows, do not suffer this direct effect, although they are affected by changes in profitability expectations.

Market Behavior: Historical Evidence

During the recent five-year period, the S&P U.S. Preferred Stock Index (which accounts for approximately 71% of the preferred stock market in the U.S.) recorded a decline of 18.05%, while the S&P 500 (dominated by common shares) increased by 57.60%. This gap illustrates the divergence in behavior under restrictive monetary policy contexts. Elevated interest rates severely penalized preferreds, benefiting common shares thanks to economic recovery and growth expectations.

Operational Process: How to Buy Both Types

Step 1: Choose a Platform

Look for a regulated broker with a solid reputation. Verify it offers access to both types of shares and, optionally, CFDs on them.

Step 2: Set Up an Account

Provide personal and financial data. Make an initial deposit according to your possibilities.

Step 3: Research Companies

Analyze balance sheets, profit margins, industry sector. Understand what you are buying—avoid blind speculative investments.

Step 4: Execute the Trade

From the platform, choose between:

• Market order: Executed at the current available price
• Limit order: Set the maximum price you will pay; execution is conditional

Step 5: Monitor and Rebalance

Review periodically. Adjust positions if the context changes, companies evolve, or your risk tolerance shifts.

Strategy Based on Investor Profile

Aggressive Investor: Prioritizes common shares. Has an extended time horizon (10+ years), high risk tolerance, aims to maximize wealth growth. Usually in early or mid stages of financial life.

Conservative Investor: Prefers preferred shares. Approaching retirement or already retired. Seeks regular, predictable income flow. Accepts lower appreciation in exchange for certainty.

Moderate Investor: Combines both. Uses preferred shares as portfolio stabilizers, common shares for growth. Reduces overall volatility while maintaining upside exposure.

Conclusion

Choosing between preferred and common shares is not about which is “better” but which aligns with your goals, time horizon, and risk tolerance. Common shares build wealth over the long term but with turbulence. Preferred shares secure regular income with less drama. A balanced portfolio combining both according to your profile can be the most robust strategy. The key is understanding each instrument and using it with a clear purpose.