Difference Between Equity Share and Preference Share ? Investing in the stock market often involves two primary types of shares: equity shares and preference shares. Both represent ownership in a company, yet they come with distinct rights and characteristics that differentiate them in terms of risk, returns, and shareholder privileges. Let’s delve deeper into each type and explore their differences to understand their roles in investment portfolios.
What Are Equity Shares?
Equity shares, also known as ordinary shares or common stock, signify ownership in a company. When individuals or institutions purchase equity shares, they become partial owners and consequently have ownership rights in the company. These rights may include voting rights at shareholder meetings and the potential to receive dividends based on the company’s profitability. Difference Between Equity Share and Preference Share
Characteristics of Equity Shares
- Ownership Stake: Equity shareholders possess residual ownership in the company, meaning they have a claim on the company’s assets after all other liabilities are paid off in the event of liquidation.
- Risk and Returns: They carry higher risk compared to preference shares because equity shareholders are last in line to receive payments in case of bankruptcy or liquidation. However, they also have the potential for higher returns through capital appreciation and dividends, which are variable and not guaranteed. Difference Between Equity Share and Preference Share
- Voting Rights: Equity shareholders typically have voting rights, enabling them to participate in major company decisions, such as electing the board of directors.
- Dividend Payment: Companies distribute dividends to equity shareholders based on profitability and at the discretion of the board of directors. The amount can vary each year or might not be paid at all if the company faces financial constraints.
- Convertible Features: Some equity shares might have convertible features that allow them to be converted into another class of securities, like preference shares or bonds, under specific conditions.
What Are Preference Shares?
Preference shares represent a hybrid form of investment that combines features of both equity and debt. They typically offer a fixed dividend, similar to interest payments on debt, and hold priority over equity shares when it comes to receiving dividends or assets during liquidation.
Characteristics of Preference Shares
- Dividend Priority: Preference shareholders have a preferential right to receive dividends over equity shareholders. These dividends are generally fixed and predetermined, offering a predictable income stream.
- No Voting Rights: In most cases, preference shareholders do not possess voting rights in the company’s decision-making processes. They sacrifice voting power in exchange for priority in receiving dividends. Difference Between Equity Share and Preference Share
- Lower Risk, Lower Returns: Preference shares are considered less risky compared to equity shares since they have a fixed dividend rate and priority in receiving payments in case of liquidation. However, their potential for capital appreciation is limited.
- Redeemable or Irredeemable: Preference shares can be either redeemable, meaning the company can buy them back after a specified period, or irredeemable, where they do not have a maturity date and act more like perpetual instruments.
- Cumulative or Non-cumulative: Cumulative preference shares entitle shareholders to accumulate unpaid dividends if not distributed in a particular year. Non-cumulative preference shares do not allow for the accumulation of unpaid dividends.
Key Difference Between Equity Share and Preference Share
- Dividend Payment: Equity shares do not have a fixed dividend rate and receive dividends based on the company’s profitability, while preference shares offer a fixed dividend rate.
- Risk and Returns: Equity shares carry higher risk and the potential for higher returns through capital appreciation, whereas preference shares offer lower risk but limited potential for capital growth.
- Voting Rights: Equity shareholders typically have voting rights, whereas preference shareholders generally do not possess voting power. Difference Between Equity Share and Preference Share
- Priority in Dividends and Liquidation: Preference shareholders have priority over equity shareholders in receiving dividends and assets during liquidation.
- Nature of Ownership: Equity shareholders hold actual ownership in the company with residual rights, while preference shareholders are more akin to creditors with preferential rights to dividends.
- Redemption and Maturity: Preference shares can be redeemable or irredeemable, while equity shares do not have a maturity date or redemption feature.
Equity vs. Preference Shares – The Basics of Investing:
For Risk-Tolerant Investors: Equity shares might be more suitable due to their potential for higher returns, although they come with higher risk.
For Investors Seeking Stability: Preference shares offer a fixed income stream and lower risk but limited growth potential compared to equity shares.
Diversification: A balanced investment strategy often involves a mix of equity and preference shares to mitigate risk while seeking returns. Difference Between Equity Share and Preference Share
Company Performance: Understanding the financial health, growth prospects, and dividend policies of companies issuing these shares is crucial for informed investment decisions.
Tax Implications: Depending on the jurisdiction, tax treatment might differ between dividends received from equity and preference shares.