Preferred shares vs common shares: the differences investors need to know

During periods of changing interest rate cycles, some assets that are often overlooked come back into focus, especially Preferred Shares, which serve as a tool balancing safety and returns. Meanwhile, common stocks remain the main driver of long-term wealth creation.

Capital Structure and Priority of Claims

When a company needs funding, it has several ways to raise capital, whether through borrowing, issuing bonds, or issuing shares. This is known as the “capital structure,” and it is crucial for risk assessment.

In the event of a crisis, preferred shares rank higher than common stocks in the remaining asset distribution. This means that if liquidation occurs, creditors are paid first, followed by preferred shareholders, and finally common shareholders.

Common Stocks: Wealth Building Tools

When most people talk about “stocks,” they usually mean Common Stock (Common Stock), which represents true ownership in the company.

Holding common stocks is akin to investing in the company’s future. If the company grows and profits, stock prices can increase many times over, making it a powerful avenue for wealth accumulation.

Rights and Returns

Common shareholders have several rights, including voting rights, decision-making at shareholder meetings, and dividends based on company profits. However, dividends are not fixed; they depend on whether the company makes a profit.

Risks Involved

The downside is that common shareholders are at the lowest level of the capital structure. In case of bankruptcy, common shareholders often lose all their capital or are left with only a small residual.

Preferred Shares: Stable Returns

Preferred Stock (Preferred Stock) is a hybrid security that combines features of bonds and common stocks.

Legally, preferred shareholders are considered owners of the company, but in practice, they act like creditors who lend money to the company in exchange for a steady cash flow.

Advantages of Preferred Shares

The main benefits of preferred shares are twofold:

Priority for Dividends: Preferred shareholders receive fixed dividends (such as 5% or 7% per year) before common shareholders get anything, making cash flows more predictable.

Priority for Capital Repayment: In bankruptcy, proceeds from asset sales are used to return capital to preferred shareholders first, offering greater protection than common stocks.

Types of Preferred Shares

The market offers various types of preferred shares, depending on the terms of each instrument:

Cumulative: If the company skips dividend payments in a year, the unpaid dividends accumulate and must be paid in full before any dividends are paid to common shareholders.

Non-cumulative: If dividends are not paid, the unpaid amount is forfeited.

Convertible: Some preferred shares can be converted into common stock at a specified ratio, opening opportunities for profit from price differentials.

Callable: The company has the right to buy back preferred shares after a certain period, often when market interest rates decline.

Deep Comparison: Preferred Shares vs Common Stocks

Why Do Companies Issue Preferred Shares?

From the issuer’s perspective, issuing preferred shares offers several advantages:

Maintaining Control: Business owners seeking funding without diluting voting power may choose preferred shares, as holders typically lack voting rights.

Improving Financial Ratios: On the accounting side, preferred shares are counted as “equity,” not “debt,” which can improve financial metrics.

Financial Flexibility: Unlike bonds, which require fixed interest payments and can lead to insolvency if missed, preferred dividends can often be deferred if necessary.

Lessons from the Thai Market Case Studies

( SCB and Parent Company Restructuring

When Siam Commercial Bank )SCB### restructured into SCBx via a Tender Offer, it highlighted the complexity of large corporate actions.

Preferred shareholders (SCB-P) were given conversion options, but those who “missed the news” or “chose not to convert” saw their original SCB shares delisted, becoming over-the-counter shares with very low liquidity, almost disappearing.

Lesson: Preferred shares may not be permanent, and shareholder structures can change abruptly.

( KTB-P: The True Liquidity Trap

While KTB common shares trade hundreds of millions daily, KTB-P preferred shares sometimes have no trading activity for days.

Investors attracted by high dividends may buy in large quantities, but when they need quick cash, they find no buyers or must sell at a loss.

Lesson: High dividends do not guarantee good investment if you cannot sell.

) RABBIT-P: Complex Conditions

RABBIT ###U City( preferred shares have a )Convertible### feature allowing investors to choose whether to remain preferred or convert to common at a 1:1 ratio.

Such cases require high expertise, as investors must calculate “Conversion Parity” to decide if conversion is worthwhile.

Investor Groups and Suitable Strategies

No asset is “the best”; there are only assets that are “most suitable” for each individual.

( For Long-Term Wealth Seekers

Investors aiming for growth, comfortable with volatility, and with a long-term horizon should choose Common Stocks, as they have unlimited upside potential.

) For Income-Focused Investors

Retirees or those seeking passive income with steady cash flows for expenses may find Preferred Shares a good option (but must be cautious about liquidity).

For Sophisticated Investors

Highly knowledgeable investors seeking risk reduction can adopt a mixed strategy, holding common stocks as a core portfolio and managing risk with various tools.

Risks to Be Aware Of

Liquidity Risk

This is the number one risk for preferred shares in Thailand. You may buy but find it difficult or time-consuming to sell.

( Call Risk

Most preferred shares have a Callable Option. When market interest rates fall, the issuer may call back the shares and reissue new ones at lower rates, causing you to miss out on potential gains.

) Interest Rate Risk

Preferred stock prices move inversely to market interest rates. When rates rise, preferred share prices decline.

Summary

The difference between Preferred Shares and Common Stocks reflects the trade-off between safety and opportunity.

Common Stocks are suitable for those willing to follow the company’s growth and tolerate fluctuations.

Preferred Shares are suitable for those seeking certainty and steady cash flow but must be mindful of liquidity and changing conditions.

Deep understanding, careful planning, and asset selection aligned with goals lead to better investment decisions.