An Investor's Guide to the Different Classes of Stocks and Shares
Not all shares in a company are the same.
When we think of investing in a company's shares, we don't often realise that companies can issue different kinds of stock. And that it matters which ones you invest in.
Companies can issue different classes of share. These can have very different rights and benefits. If you are trying to make money investing in shares you need to understand the different classes and the pros and cons of each.
Bear in mind that not all companies issue every class of share. Some will have only ordinary shares (definition coming up). Also different jurisdictions sometimes have different terminology for different classes.
The following sections will describe the most common classes of share, their characteristics and the advantages and disadvantages for investors.
These are the shares most of us think of. And most companies only issue ordinary shares.
These shares give you:
- A right to vote in company decisions
- A share of the dividends paid out.
- A share of the assets if the company is wound up.
Even within ordinary shares though, companies sometimes issue different ordinary shares.
Sometimes they have different nominal share values. This gives different voting rights.
If you own 10 10c shares in a company you have only $1 share of the nominal capital. But you have 10 votes. If I have 1 $1 share, I have the same dividend payouts as you. But I have only one vote.
Also companies sometimes issue different blocks of shares (e.g. A and B shares) which might elect different board members. This may have been a way of ensuring representation for some minority shareholders, or the result of mergers paid for in shares.
Investing in ordinary shares gives you a share in the future profits of the company. But you risk losing some or all of your money if the company does bust, or even if it struggles in future.
If you can afford to lock your money away for a reasonable amount of time, historically investing in a diversified portfolio of ordinary shares has given the best return on your money compared to other asset classes.
Non Voting Shares
Non-voting shares are identical to ordinary shares, except they have no voting rights.
These are typically issued to employees as part of share incentive schemes to avoid diluting control of the company.
Non-voting shares will pay dividends the same as ordinary shares. They are normally just as tradable (unless they are redeemable as well), but may trade at a slight discount if voting rights are valued by the market.
Most of the time most investors don't have an immediate need for voting rights but it can be an important control to make sure that the company is not run in a way that is totally against your interests.
Preference shares get first preference on dividend payouts - hence the name. Essentially investors in preference shares trade off more certain payouts against giving up some future growth potential.
Dividend payouts are usually fixed in the rules in advance as a certain % of the nominal value. Unlike ordinary shares these dividends won't go up with company performance. But they will only go down if the company is in serious trouble.
These differences make preference shares a bit like a hybrid between corporate bonds and shares.
For example, unlike debt the company does not have to pay out if there are not profits available. But like corporate bonds, typically preference shares don't have voting rights (unless the dividend wasn't paid) or a share in any surplus when he company is wound up.
On the plus side:
- Like bonds preference shares give you more certain returns and
- Higher cash payouts per unit invested compared to ordinary shares
On the down side
- They are not as secure as bonds and
- They don't have the growth potential of ordinary shares.
Deferred Ordinary Shares
These are shares that only get dividends if the ordinary shares have been paid a minimum amount.
Deferred Ordinary Shares will do well if the company grows and makes increasing levels of profits. If the opposite happens they may receive nothing at all.
While preference shares are lower risk that ordinary shares deferred ordinary shares are higher risk. Since, generally speaking, investments that are higher risk have higher returns to compensate, and lower risk assets have similarly lower returns, we should expect:
Preference share returns < Ordinary share returns < Deferred ordinary share returns.
At least on average and over the long term. For a specific company that actual returns will depend on what happens to that company.
Relative Risk and Reward of Different Share Types
Type of share
Management shares are generally ordinary shares but with extra voting rights so that the management can retain control of the company.
This is the strategy used by Mark Zuckerberg to keep control of Facebook.
By definition these are not going to be available to ordinary investors like you and I. But it is worth knowing if they exist for the companies you invest in. Are you happy that management can ignore their shareholders? Is it good because it allows them to make the right strategic choices without interference? Or bad because management are not accountable to their investors?
Voting, Capital and Dividend Shares
Sometimes companies will even split their shares into three types:
- one with the voting rights,
- one with rights to capital surplus and
- one with rights to dividends.
This is to allow bespoke splits of these rights between investors.
Typically this would be done in private companies for specific investors. Stocks you buy through your broker are unlikely to be set up this way. But be aware it is possible and don't make assumptions. As with any investment - read the small print.
A Simple Summary
If all these different classes and their plusses and minuses seems confusing. Here are the three key things you need to know and remember.
1. Companies can have different classes of shares with different rights and benefits.
2. Understand what rights and benefits the shares you buy have and whether they matter to you.
3. Also understand how others value those rights and benefits - because that affects how easy these shares will be to sell.
Remember these three and so long as you read the small print you will be able to work out what you need to know.
This article is provided as information and nothing in it should be read as financial advice. You might like to consult a financial adviser in your jurisdiction who will be able to give advice based on your circumstances.