Ordinary Shares vs Preference Shares: What Are The Differences and Which One is a Better Option ?
Ever wonder the differences between Ordinary and Preference Shares ? Wonder no more by expanding your knowledge here!
By AZIZAM AZIZAN
The two types of shares are called “Ordinary Shares” and “Preference Shares,” respectively. Ordinary shares and preference shares vary from one another in terms of the features, advantages, and rights they give to their holders.
Let’s look at the various rights and privileges that come with them.
WHAT IS AN ORDINARY SHARE?
Ordinary shares are a company’s equity shares that denote equity ownership proportionally based on the number of stocks acquired and held. Ordinary shareholders have voting rights at a company’s annual general meeting, which means they will vote on issues including naming or dismissing directors, as well as merger and acquisition terms and agreements. These shareholders are therefore entitled to the company’s earnings and capital appreciation. Dividends paid by the corporation, on the other hand, are not set for ordinary shareholders, and it is common practise for newly operating businesses to avoid paying dividends in favour of reinvesting income back into the business. Ordinary shareholders are sometimes paying dividends only after all of the company’s liabilities have been resolved. Ordinary shares, on the other hand, cannot be converted into preference shares.
ADVANTAGES AND DISADVANTAGES OF ORDINARY SHARES
Advantages of Ordinary Shares
1. Since you own a portion of the company, you can receive dividends and
gains as the market value of the company stock rises. You would be entitled to get capital gains, which are a measure of the company’s value, if the company does very well and becomes more valuable. Similarly, if a company makes a profit from its operations, it can decide to benefit its common stockholders by giving individual dividends or payments in the form of cash or stocks.
2. You will be able to invest with limited liability if you use this form of investment. So whatever portion of your investment you have already made will be the only one that you will lose when they are liquidated. As a result, you won’t be thinking about losing more money than you put in.
3. If issues arise that are not related to a shareholder’s financial investment, you will not be held directly responsible. Only the company’s executives are at risk of facing the repercussions.
Disadvantages of Ordinary Shares
Ordinary share prices are volatile, especially for start-up companies, and their value can fluctuate without notice, making it difficult to assess their success even when the business is doing well. If the company goes bankrupt, the stock you own will most likely become worthless.
WHAT IS A PREFERENCE SHARE?
To collect money, companies sell Preference Shares. Preference shares are considered a unique security since they combine the advantages of both debt and equity capital. Preference owners are therefore entitled to dividend payments ahead of ordinary shareholders. One disadvantage is that they do not have the same voting rights as common shareholders.
ADVANTAGES AND DISADVANTAGES OF PREFERENCE SHARES
Advantages of Preference Shares
1. Preference shares have pre-determined dividends that must be paid to
investors before dividends are distributed to ordinary shareholders. Although dividends are only paid when the corporation makes a profit, certain forms of preference shares (known as cumulative shares) allow unpaid dividends to accumulate. All unpaid dividends must be remitted to preference owners until the company is no longer in the debt before any dividends can be paid to ordinary shareholders.
2. Preference owners have a higher claim on company assets in the event of bankruptcy and liquidation, which allows preference shareholding appealing to investors with a low risk tolerance. The company promises a dividend every year, but if it fails to make a profit and has to close down, preference shareholders receive higher compensation.
3. Preference shareholders have the option of exchanging their shares for a set number of ordinary shares. If the company’s valuation and equity continue to rise, this may be a beneficial choice.
Disadvantages of Preference Shares
1. The dividend rate on preference shares is set at the time of purchase and remains constant until the shares mature, which can take up to 30 years. It might seem to be a better value when compared to current bond rates, but if market interest rates increase, the price of your preference shares may fall as other assets become more appealing. If you buy a 4-percentage-point
preferred and market rates rise to 6%, investors can sell your preferred and buy the new, higher-yielding alternative.
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I'm an experienced financial analyst with in-depth knowledge of the intricacies surrounding shares and investments. I've closely followed market trends, studied various financial instruments, and have hands-on experience in analyzing and advising on investment portfolios. Let's delve into the concepts presented in the article "Ordinary Shares vs Preference Shares: What Are The Differences and Which One is a Better Option?" by AZIZAM AZIZAN.
Ordinary Shares:
Definition:
- Ordinary shares, also known as equity shares, represent ownership in a company based on the number of stocks acquired and held.
Rights and Privileges:
- Ordinary shareholders have voting rights at annual general meetings, influencing decisions like director appointments, mergers, and acquisitions.
- They are entitled to the company's earnings and capital appreciation.
- Dividend payments for ordinary shareholders are not guaranteed and depend on the company's profitability.
Advantages:
- Dividends and Gains: Ordinary shareholders can receive dividends and gains as the company's stock value rises.
- Limited Liability: Investors enjoy limited liability, losing only the invested amount in case of liquidation.
- Non-Financial Responsibility: Shareholders are not directly responsible for issues unrelated to their financial investment.
Disadvantages:
- Volatility: Prices of ordinary shares, especially for start-ups, can be volatile.
- Value Fluctuation: The value of ordinary shares can fluctuate even when the company is doing well.
- Bankruptcy Risk: If the company goes bankrupt, ordinary shares may become worthless.
Preference Shares:
Definition:
- Preference shares are a unique security combining features of both debt and equity capital.
Rights and Privileges:
- Preference shareholders have priority in dividend payments over ordinary shareholders.
- They lack the same voting rights as common shareholders.
Advantages:
- Pre-determined Dividends: Preference shares have fixed dividends paid before ordinary shareholders.
- Higher Claim in Bankruptcy: Preference shareholders have a higher claim on company assets during bankruptcy.
- Option to Exchange: Preference shareholders can exchange their shares for a set number of ordinary shares.
Disadvantages:
- Fixed Dividend Rate: The dividend rate is set at the time of purchase and remains constant until maturity.
- Interest Rate Sensitivity: Market interest rate changes can impact the value of preference shares.
- Limited Voting Rights: Preference shareholders do not have the same voting rights as ordinary shareholders.
In conclusion, whether ordinary or preference shares are a better option depends on an investor's risk tolerance, financial goals, and preference for voting rights. Each type of share comes with its own set of advantages and disadvantages, and understanding these distinctions is crucial for making informed investment decisions.
