Introduction
Although it’s easy to forget sometimes, a share of stock is not a lottery ticket. It’s part ownership of a business. – Peter Lynch.
Owning shares is more than just a financial investment. It symbolises a stake in the company’s future growth and potential. Thus, before taking a stake, it’s essential to know that ownership can take two primary forms—equity and preference shares.
Both forms present specific opportunities and potential drawbacks that suit various investment styles. Let us explore these two forms of ownership and their key differences.
Also read: Different types of shares
What are equity shares?
What is the meaning of equity? In simple terms, equity shares give you part ownership in a company.
Once you buy equity shares, you become the part owner of that specific company – the shares of profits and its assets. But, the share of profits and assets comes after the company’s creditors and preference shareholders.
Holding equity shares allows you to earn through two ways:
- Through capital appreciation (when the price of shares increases) and
- Through dividend
The value of your shares can fluctuate significantly, depending upon the market conditions, the company’s performance, and investors’ sentiment. Volatility may in turn result in gain, but there is also a potential for loss.
Liquidity is also a plus point for equity shareholders. You can easily buy and sell equity shares on the stock exchange.
In equity shares, one also gets voting rights. These voting rights help influence decisions within a company by electing the board of directors or using their voting power for the approval of major corporate actions. But for that, the shareholding should be significant.
Types of equity shares
The categorisation of equity shares is done as follows:
- Authorised share capital
- Subscribed share capital
- Issued share capital
- Paid-up capital
- Right shares
- Sweat equity shares
- Bonus shares
Must read: Everything you need to know about the issuance of bonus shares
What are preference shares?
Preference shares meaning needs to be understood more.
Preferred shares or preference shares represent a class of ownership. They are called preferred shares as they rank ahead of equity shares on the assets and profits of the company in terms of priority claims. They fall between debt and equity in terms of capital repayment hierarchy.
Fixed dividends are paid to these shareholders, which makes them suitable for persons seeking regular or steady earnings. Also, during liquidation, preferred shareholders have senior claims to the company’s assets.
However, these shares don’t carry voting rights. Additionally, they can be easily converted into equity shares at any time.
Types of preference shares
The following are the major types of preference share:
- Cumulative preference shares
- Non-cumulative preference shares
- Redeemable preference shares
- Non-redeemable preference shares
- Convertible preference shares
- Participating preference shares
- Non-participating shares
Key differences between equity and preference shares
Here is a snapshot of the differences between equity and preference shares:
| Aspect | Equity Shares | Preference Shares |
| Ownership | Represent ownership in the company. | Entail a guaranteed priority over the company’s assets. |
| Voting rights | Yes, voting rights are given to equity shareholders. | No, voting rights are not available to preference shareholders. |
| Dividend payment | Dividends depend on profits and are not fixed | Dividends are fixed and are given priority before equity shareholders. |
| Return | Potential capital appreciation | Consistent dividend income |
| Risk | Higher risk; dividends may not be paid in losses. | Lower risk; more stable returns due to fixed dividends. |
| Claim on assets | In case of liquidation, last to be paid. | Have a preferential claim on assets over equity shareholders. |
| Share price | Prices fluctuate based on market conditions. | Prices are generally more stable. |
| Bonus shares | Eligible | Not eligible |
| Conversion | Cannot be converted into other securities. | May be convertible into equity shares in some cases. |
| Rights in liquidation | Shareholders may receive residual assets after creditors/preference shareholders are paid. | These shareholders are paid before equity shareholders during liquidation. |
| Arrears of dividend | Equity shareholders do not have the right to claim unpaid dividends. | Some categories of preference shareholders are entitled to receive unpaid dividends. |
| Mandate | Issuing equity shares is a requirement for every company. | However, all companies don’t need to issue preference shares. |
| Liquidity | High, traded on stock exchange | Low |
| Suitable for | Long-term investment | Medium to short-term investment |
What investors should choose?
Before investing in any equity or preference shares – investors must determine what they want to achieve and consider their risk appetite.
Equity shares provide the possibility of capital appreciation, but they come with risks and volatility. Therefore, they may suit people who are growth-seekers.
Preference shares provide fixed rate dividends and are less risky, hence suitable for income-seekers. Additionally, they occupy a middle ground in the hierarchy of capital repayment, positioned between debt and equity.
All these, along with being updated with market conditions, financial conditions of companies, tax implications on the investment, and many more, would help you select ownership that would align with your financial objectives.
You may also like: Low price share vs high price share
Bottomline
To sum it up, equity shares and preference shares both have specific pros and cons for the investors. Equity shares give ownership plus the right to vote, and you can expect to earn higher potential returns. Hence, it is more suitable for risk lovers.
Preference shares, however, offer fixed dividends with higher claims over assets and hence are a more secure and less risky income-generating instrument.
When making the choice between the two, ascertain your investment strategy, risk appetite and the need for control of your investment. Knowing the types of shares will help you make wise choices concerning your investment portfolio.
FAQs
1. What is the difference between equity shares and preference shares?
Both are different in many ways. Equity shares give ownership plus the right to vote, and you can expect to earn higher returns. Hence, it is more suitable for risk lovers. Higher liquidity than preferred shares is one of the key advantages.
Preference shares, however, offer fixed dividends with higher claims over assets and hence are a more secure and less risky income-generating instrument. But they come without voting rights and bonus issues.
2. What is the difference between preference shares and equity debentures?
Yes, all three options are different. Debentures are a form of debt security that generally carry the least amount of risk among all investment instruments and pay fixed rate interest without any right to ownership or voting authority. Preference shares are hybrid securities with fixed dividend payments and carry usually restricted or no rights to vote.
In contrast, equities provide equity shareholdings with a part stake in a company’s ownership along with voting rights while offering the potential for higher returns.
3. What is preferred equity or preference shares?
Preferred equity or preference shares are a type of ownership. They rank ahead of common shares on the assets and profits of the company in terms of priority claims. In this sense, in reality, they fall between debt and equity in terms of capital repayment hierarchy.
Fixed dividends are paid to these shareholders, which makes them suitable for persons seeking regular or steady earnings. Also, during liquidation, preferred shareholders have senior claims to the company’s assets.
4. Why is it called preferred shares?
Preferred equity or preference shares represent a class of ownership. They are called preferred shares as they rank ahead of equity shares on the assets and profits of the company in terms of priority claims. They fall between debt and equity in terms of capital repayment hierarchy.
Fixed dividends are paid to these shareholders, which makes them suitable for persons seeking regular or steady earnings. Also, during liquidation, preferred shareholders have senior claims to the company’s assets.
5. What are the disadvantages of preference shares?
Preference shares have some disadvantages. Firstly, preference shares have no voting rights, thereby diluting the powers of the shareholders in matters of a vote.
Secondly, it offers fixed dividend payments but the dividends paid are always lower than what an investor derives from equity. This restricts capital appreciation in contrast to equity shares. A preference shareholder is paid after debt-holders but before the equity shareholder in case of winding up. Fourthly, the marketability is lower as compared to equity shares.
