Stock Basics: Types of Shares Issued by Companies

The financial landscape can be daunting for new investors, but understanding the fundamentals of stocks is crucial for navigating this exciting world.

Companies issue stocks, also known as shares, to raise capital for growth and operations. These shares represent fractional ownership in the company, and the type of share you own determines your rights and privileges as an investor.

This comprehensive guide dives deep into the various types of shares commonly issued by companies, exploring their characteristics and implications for investors.

By grasping these nuances, you can make informed investment decisions aligned with your financial goals and risk tolerance.

Common Shares (Ordinary Shares)

Common shares are the most prevalent type of stock. When someone mentions “investing in stocks,” they’re typically referring to common shares. Owning common shares grants you ownership rights in the company, entitling you to share in its profits through two main channels:

• Dividends: Companies distribute a portion of their profits to shareholders as dividends. While not guaranteed, dividends offer a steady stream of income for investors seeking regular returns.
• Capital Appreciation: Ideally, the company’s stock price will increase over time, allowing you to sell your shares at a profit. This potential for capital appreciation is a key driver for many investors.

Key Characteristics of Common Shares:

• Voting Rights: Common shareholders typically have voting rights on crucial company matters. This includes electing the board of directors, who oversee the company’s management, and voting on significant proposals that impact the company’s long-term direction. These voting rights allow common shareholders to have a say in the company’s future.
• Dividend Payments: The company’s board of directors determines dividend distribution. They might choose to reinvest profits for future growth or distribute them to shareholders as dividends. The decision to pay dividends and the amount distributed can be influenced by various factors, such as the company’s financial health, growth plans, and overall market conditions.
• Residual Claim on Assets: In the event of liquidation (company closure), common shareholders have the last claim on the company’s remaining assets after debt and obligations to preferred shareholders are settled. However, this residual claim may be minimal if the company has significant debts.

Preferred Shares

Preferred shares offer an alternative to common shares, catering to investors seeking a more predictable return and a degree of security.

Unlike common shareholders, preferred shareholders typically forego voting rights in exchange for certain preferential treatment:

• Fixed Dividends: Preferred shareholders receive fixed dividend payments at regular intervals, usually quarterly. These dividends are typically predetermined and must be paid before common shareholders receive any dividends. This fixed income stream provides a level of predictability for investors seeking regular payouts.
• Priority in Liquidation: If a company goes bankrupt and liquidates its assets, preferred shareholders have a higher claim on those assets than common shareholders. This provides some security of receiving a return on their investment, even if the company is failing.

Key Characteristics of Preferred Shares:

• Fixed Dividend Payments: Preferred shares offer a predictable stream of income through fixed dividend payouts, making them attractive to investors seeking regular returns.
• Priority in Liquidation: Preferred shareholders have a higher claim on company assets in case of liquidation, offering some protection over common shareholders. This prioritization provides a level of security for investors’ capital.
• No Voting Rights: Generally, preferred shareholders do not have voting rights in the company, relinquishing control over certain company decisions. This is a trade-off for the fixed income and priority in liquidation benefits.

Dual-Class Shares

Dual-class share structures introduce a different dynamic to corporate governance. Companies may issue two classes of shares, often designated as Class A and Class B. The key distinction lies in the voting rights attached to each class:

• Unequal Voting Rights: One class of shares, often held by company founders or major stakeholders, carries significantly more voting power than the other class, which is usually available for public trading. This allows founders or insiders to maintain control over the company even with a minority ownership stake through votes. This structure can be used to ensure founders have a say in the company’s direction despite not holding a majority of the shares.
• Control Retention: Dual-class structures enable founders or insiders to retain control over strategic company decisions despite potentially owning a smaller portion of the company’s shares. This allows them to steer the company’s future according to their vision.
• Potential for Conflict: This unequal voting power can create conflicts of interest. The interests of controlling shareholders with more voting power may diverge from those of minority shareholders with less voting influence. This can lead to situations where decisions are made that prioritize the interests of controlling shareholders over the overall value of the company.

Additional Share Types

Beyond the primary categories of common, preferred, and dual-class shares, several other share types exist, each with unique features that cater to specific investment strategies:

• Convertible Preferred Shares: These shares offer flexibility, combining characteristics of both preferred and common shares. They function as preferred shares, offering fixed dividend payments and priority in liquidation. However, they come with the added benefit of convertibility. Under certain predetermined conditions, such as reaching a specific stock price, convertible preferred shares can be converted into a fixed number of common shares. This allows investors to benefit from potential capital appreciation enjoyed by common shareholders while also enjoying the fixed income and security features of preferred shares.

• Redeemable Preferred Shares: These shares provide an element of flexibility for both the company and the investor. The company issuing these shares has the right to repurchase them from shareholders at a predetermined price after a certain period, typically several years. This allows the company to manage its capital structure and potentially improve its financial flexibility. For investors, redeemable preferred shares offer the security of a fixed income stream with the possibility of the company repurchasing the shares at a premium price in the future.

• Treasury Shares: A company may choose to buy back its own shares from the market for various reasons, such as to improve its earnings per share ratio, increase its ownership stake, or for employee stock option plans. These repurchased shares become treasury shares and are no longer considered outstanding. This has implications for financial ratios like earnings per share (EPS), which is a key metric used to evaluate a company’s profitability. A decrease in outstanding shares due to treasury stock can lead to a higher EPS, potentially making the company appear more profitable. However, it’s important to consider the underlying reasons for the share buyback and not solely rely on EPS to assess the company’s health.

• Tracking Stocks: These are a unique type of security that doesn’t directly represent ownership in a company but rather tracks the performance of a subsidiary or an unaffiliated company. The value of a tracking stock is directly linked to the performance of the underlying entity it tracks. Investors might choose to invest in tracking stocks if they are interested in a particular subsidiary or unaffiliated company but don’t have the ability to directly invest in it.

Factors to Consider When Choosing a Share Type

Understanding the different types of shares empowers you to make informed investment decisions. Here are some key factors to consider when choosing a share type:

• Investment Goals: Are you seeking regular income, capital appreciation, or a balance of both? Common shares offer the potential for capital appreciation, while preferred shares provide a steady income stream. Dual-class shares might be attractive if you value founder control and long-term vision, but be aware of potential conflicts of interest. Consider your investment goals and choose the share type that best aligns with them.
• Risk Tolerance: Common shares generally carry higher risk due to their price volatility. Preferred shares offer a more predictable return but may have limited growth potential. Dual-class shares can be even riskier due to the potential for conflicts of interest. Evaluate your risk tolerance and choose a share type that aligns with your comfort level.
• Investment Horizon: Are you investing for the short or long term? If you need access to your capital quickly, common shares might not be suitable due to potential short-term price fluctuations. Preferred shares can be a good option for long-term income generation. Consider your investment horizon and choose a share type that aligns with your timeline.

Final Thoughts

By understanding the different types of shares and the factors to consider when choosing them, you can navigate the investment landscape with greater confidence.

Remember, there is no “one-size-fits-all” approach to investing. Carefully analyze your investment goals, risk tolerance, and investment horizon to make informed decisions that align with your financial strategy.