April 21, 2020
When thinking of a company’s stock, the general investor is most likely considering its common shares. However, a company can issue many forms of equity, defined by classes, just like debt. What are the types, general differences, and when might it make sense to add a “less-common” share class to your portfolio.
Common stock is the most familiar share class. Owning a share of common stock in a company represents a percentage of ownership. For simplicity's sake, percentage of ownership is the number of shares owned dividend by the total shares issued by the company. Attached to owned shares are voting rights, most commonly at a 1-for-1 ratio. These voting rights are used as a way for shareholders to voice their opinions in corporate initiatives defined by the board of directors. While some companies are known for being consistent dividend payers, owners of common shares are not promised to receive dividends, even if the company has a strong history of distributions. If the company falls on hard times, use profits to buy back shares of their own company, or invest in R&D over paying a dividend, it is at their discretion to do so.
Preferred stock combines features of common stock and bonds. One of the attractive features of owning preferred shares is a “guaranteed” (using this term loosely) dividend rate issued by the company as a percentage of par value of the preferred share. For example, if par value of one share of preferred stock is $10 and the dividend rate is 3%, the shareholder will collect $0.30 in dividends. Preferred stock owners have higher claim to dividends and company assets than common stockholders. If a company misses or suspends paying a preferred dividend, it must make whole their preferred stock owners before it can pay any common stock dividend. In exchange for greater dividend security, preferred shares typically do not possess voting rights. Like common stock, the market value of a preferred share changes daily. Price fluctuations are heavily influenced by changing interest rates and creditworthiness of the issuer because of their bond-like features, but are typically less volatile than common shares.
A third share class, convertible preferred, combines the features of common shares and preferred shares, but not simultaneously. Owning convertible preferreds give the holder, but sometimes the issuer, the right to convert their shares of preferred stock to shares of common stock on a predetermined date. For example, if a convertible preferred has a conversion ratio of five, this means upon conversion, the stock owner can exchange one share of preferred for five shares of common. As the share price of the common stock rises (which may or may not move in tandem with the preferred share value), the appeal of converting to common shares may increase. However, owning shares of common stock exposes the stockholder to greater price volatility than that of preferred shares.
Deciding which share class to add to your portfolio should be evaluated while taking risk tolerance, time horizon, and investment objective into consideration. Preferred share classes are generally viewed as a more conservative investment with income generating features, while common shares offer a greater capital appreciation opportunity at the cost of greater volatility and less secured dividend income. Inherent risk is embedded in all share classes and should be assessed like any other investment decision.
TiiCKER was created for fan-first, brand-first public companies—with exclusive perks served-up weekly to shareholders. Own stock? Connect your brokerage account to view more than 130 perks waiting for you right now!