Common shares are the more common type of stock and are often referred to simply as stocks. Preferred stock, on the other hand, has characteristics that resemble both stocks and bonds.
Bonds are financial instruments used to generate income, representing a debt that the bond issuer agrees to repay at a future date, along with regular interest payments. This is similar to a company borrowing money from a bank or taking out a loan. Bonds typically have a fixed maturity date, with the principal repaid at the end of the term. Unlike loans that require regular installment payments, bondholders receive interest payments at regular intervals.
Preferred shares, while not maturing like bonds, have characteristics that resemble debt instruments. They have a higher priority compared to common shares in terms of both income distribution and claim on assets if the company faces financial distress. Preferred shareholders receive their dividends before common shareholders, and in case of insolvency, they have a higher claim on company assets compared to common shareholders.
Dividends on preferred shares are often set at a fixed rate, similar to interest payments on bonds. This makes preferred shares attractive to income-focused investors. On the other hand, dividends on common shares are variable and depend on the company’s decision to declare and distribute dividends during a given period.
One key difference between preferred shares and common shares is voting rights. Preferred shareholders typically do not have voting rights, while common shareholders do. However, for the average investor with a small stake in a company, the voting rights associated with common shares usually have minimal impact or influence.
Understanding the distinction between common shares and preferred shares is important for investors as it allows them to make informed decisions based on their investment goals, risk tolerance, and desired income generation.
Common Stocks Compared to Preferred Stocks
Preferred stock is particularly appealing to investors seeking a stable rate of return and reliable income over time. It can be an attractive investment option for those who prioritize stability and consistent dividends. Preferred shares offer guaranteed dividends at a fixed rate or adjustable dividends linked to interest rate indexes like LIBOR. Although adjustable rate shares may have yield adjustments based on factors like business performance, preferred shares generally provide more stable and reliable dividends compared to common shares.
On the other hand, common shares offer greater liquidity as they have a larger number of shares issued and are more actively traded. The higher trading volume and demand for common shares result in easier trading and tighter bid-ask spreads. Common shares provide investors with the potential for both dividends and capital appreciation. They are typically bought with the expectation of seeing an increase in value over time.
Some preferred shares are callable, meaning the issuing company has the right to buy them back at the issue price. This allows companies to manage their capital structure according to their business needs. Callable shares may be redeemed if the company wants to issue new shares with lower yields, for example.
Companies can also buy back their common stock, but they must do so on the open market. Share buybacks by a company can increase demand and drive up the price of common shares in the short term. Additionally, reducing the number of outstanding shares theoretically adds value to the remaining shares.
Preferred shares are often seen as a reflection of a company’s creditworthiness, similar to bonds. In contrast, common shares reflect a company’s current business conditions and future prospects. Therefore, common shares are more tied to the company’s performance and growth potential.
Understanding the distinctions between preferred shares and common shares helps investors choose investments aligned with their objectives, whether it be stability and income generation (preferred shares) or growth potential (common shares).
Differences Between Stocks
In South Africa, companies may issue separate series of common stock to create different classes. To designate the class of shares, you will typically see a dot and a letter after the stock symbol. However, not all stocks are traded on stock exchanges. Some stocks are traded on traditional exchanges like the Johannesburg Stock Exchange (JSE), while others may be traded on electronic exchanges such as the Alternative Exchange (AltX) in South Africa. Additionally, certain stocks are not traded on exchanges at all but are bought and sold directly from dealers who maintain an inventory. These stocks often have low market capitalization and trading volume.
Some stocks in South Africa are components of stock indexes, such as the FTSE/JSE Top 40 Index or sector-specific indexes on the JSE. Stocks included in major indexes tend to experience higher trading volumes due to the inclusion of these stocks in portfolios, funds, ETFs, and derivatives that track the performance of the index.
Certain stocks are considered “blue chip” stocks due to the size of the company and its history of success. Blue chip stocks are generally preferred by many investors, especially those with a long-term investment approach, as they are perceived to offer greater stability.
Stocks in South Africa are also categorized by sector, based on the type of business the underlying company operates in. Different sectors may have distinct characteristics influenced by investor behavior and associated risks. For example, certain sectors may be in high demand, such as technology stocks during various periods in recent history.
Furthermore, stocks can be classified based on income and growth potential. Income stocks are those that tend to pay regular and reliable dividends, while growth stocks focus more on capital appreciation. Depending on an investor’s strategy, they may choose to focus more on income stocks or growth stocks.
