Understanding Preference Shares vs Ordinary Shares

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When it comes to investing, there are a variety of different types of shares that you can purchase. Two of the most common types of shares are preference shares and ordinary shares.

Understanding the difference between these two types of shares is important if you want to make smart investment choices. Shares are a type of investment that represents an ownership stake in a company.

When you buy shares, you become a part-owner of the company, and you have a claim on its assets and earnings. There are a variety of different types of shares available, including ordinary shares, preferred shares, and bonds.

What are Ordinary Shares?

Ordinary shares are the most common type of share. They give you ownership rights in the company and allow you to vote on important issues, such as the election of directors. Ordinary shareholders also have a claim on the assets and earnings of the company.

What are Preference Shares?

Preference shares are a type of share that offers certain rights and privileges over ordinary shares. For example, preference shareholders may be entitled to a fixed dividend payment that is paid before any dividends are paid to ordinary shareholders.

Preference shares may also have priority over ordinary shares in the event of company liquidation. Preference shares can also be classified on the basis of their rights with respect to the payment of dividends. For example, preference shares may either be cumulative or non-cumulative.

Cumulative preference shares entitle their holders to the preferential dividend in case there has been a default by the company in declaring dividends for prior years, provided that all the arrears have been paid.

Non-cumulative preference shares, on the other hand, do not entitle their holders to the preferential dividend in case of default by the company. Differences between Ordinary shares and Preference shares are:

  • On the basis of Dividend Payment:

Ordinary shares are those which are entitled to dividends as and when declared by the company, out of its profits. The quantum of dividends may differ from time to time and it is not guaranteed.

Preference shareholders, on the other hand, are always entitled to a fixed dividend, which is paid before any dividends are paid to the holders of ordinary shares.

For example, if a company has declared Rs.10 as dividend per share, then the holders of ordinary shares will get Rs.10 per share and the holders of preference shares will get Rs.10 per share irrespective of what the company earns subsequently.

  • On the basis of Voting rights:

The holders of ordinary shares are entitled to one vote per share, whereas, preference shareholders are not entitled to any voting right. This means that they do not have any say in the management decisions like the appointment of directors etc.

However, it is to be noted that certain preferred stocks provide the holders with voting rights. For instance, the holders of preference shares in Tata Motors Ltd. are given voting rights.

  • On the basis of Redemption:

The majority of preference shares are non-redeemable, which means that they cannot be bought back by the issuer. The only consideration payable at redemption is the face value for a specified number of years after issue, irrespective of any increase or decrease in their market value during this period.

  • On the basis of Liquidation:

In the case of a company's liquidation, the first claim on its assets is made by the holders of its debentures and then by the holders of its preference shares.

Preference shareholders are paid before holders of ordinary shares in case of liquidation. The priority of preference shareholders is protected by law and they recover the full amount of their investment even if no dividend has been declared for ordinary shareholders.

How are Ordinary shares and preference shares the same?

Both shares represent ownership in a company and their holders enjoy the same rights. These rights include the right to vote on important issues, the right to receive dividends (if declared), and the right to receive company assets in case of liquidation.

What are the benefits of buying shares?

There are a few benefits of buying shares, including:

  • Gaining ownership in a company and having a say in its management decisions.
  • Receiving dividends (if declared) and company assets in case of liquidation.
  • Potentially earning higher returns if the company does well financially.

However, it is important to note that there is always some risk associated with investing in shares. You could lose some or all of your investment, so please consult a financial advisor before making any decisions.

What points should be kept in mind before buying a share of a company?

That depends on your investment goals and risk tolerance. If you are looking for a regular income stream, then preference shares may be a better option. However, if you are willing to take on more risk in order to potentially earn higher returns, then ordinary shares may be the better choice.

You should make sure that:

  • The company is well-established and does business in a regular, profitable manner.
  • The dividend (if any) declared per share is good enough to make it worth your while.
  • The payment you will receive upon liquidation will be more than the total amount of money you invested. A stock typically goes up in value over time, but it may also go down.

This is only a rough guideline and does not include all of the finer details that can make or break your investment. Please consult a financial advisor before making any major decisions.

Some Related FAQs:

What is Dividend?

The dividend is a payment given to shareholders out of a company's profits. It can be in the form of cash, shares, or other assets.

Are preference shares riskier than ordinary shares?

It depends on the company. Some companies are riskier than others, so you would need to do your own research before deciding whether or not to invest in preference shares.

Can I sell my shares at any time?

Yes, you can sell your shares at any time provided there is a willing buyer. If you are selling your shares then you should know that you will only receive the current market value of the shares.

Is ownership limited to just one share?

No, you can buy more than one share. There is no restriction on how many preference shares or ordinary shares you can buy at any time, provided there is enough money in your account.

Where can I buy shares?

You can buy preference and ordinary shares from a company's authorized dealer, usually a bank or brokerage firm.

Will my dividends increase as more people buy preference and ordinary shares?

It depends on the company. Some companies pay higher dividends when there is increased demand for their shares, so you would need to do your own research before making any decisions.

How can I find out more about preference shares?

You can visit the website of each company to find out more about their preference shares. You can also read annual reports, or speak with a financial advisor for more information.

Do investors need to pay tax on dividends earned from preference and ordinary shares?

It depends on the country you reside in. In some countries, dividends are taxed at a lower rate than regular income. In others, they are taxed at the same rate. You should speak with a tax advisor to find out more about how taxes would apply to your situation.

The Bottom Line:

There is no one-size-fits-all answer to this question. It depends on the individual company, so you would need to do your own research before deciding which type of share to buy. Generally speaking, preference shares are less risky but may offer lower returns, while ordinary shares are riskier but may offer higher returns. You should speak with a financial advisor to find out more about how these shares can fit into your investment portfolio. Thanks for reading!

Michael Restiano

I lead product content strategy for SaltMoney. Additionally, I’m helping our broader team of 4 evolve into a mature content strategy practice with the right documentation and processes to deliver quality work. Prior to Instacart, I was a content strategy lead at Uber Eats and Facebook. Before that, I was a content strategist at SapientNitro, helping major Fortune 500 brands create better, more useful digital content.