How to Difference Between Equity Share And Preference Share

We go through several news channels, business channel discussions, and articles on financial blogs that talk about regular stocks. Those are basically equity shares. 

But there’s another type of share called preference share that companies issue to raise additional capital for business operations to control its debt to equity ratio.

The debt-to-equity (D/E) ratio is the percentage calculated by dividing a company’s total liabilities by its shareholder equity that denotes between the company’s liabilities and capital. A lower D/E ratio means lower debt and more profitable business. 

On the other side, some investors invest in preference shares because the company offers fixed dividends that ensure lower risk. 

Let’s talk about what’s difference between equity share and preference share in detail to let you understand which one is suitable for your investment goals.

Difference Between Equity Share And Preference Share

What is Equity Share

Equity share is an ordinary share we talk about in our daily life. The company offers partial ownership in the business to the shareholder of equity shares.

That means you get the voting rights to participate in major business decisions if you are holding equity shares of the company. Voting rights depend on the percentage of shares you hold.

For example, investors like Rakesh Jhunhunwala who take major stakes in a company’s equity shares can participate in the voting for certain company’s decisions.

When a company earns profits, it distributes its profits as dividends to the shareholders. But you’ll receive dividends only if the company is making profits.

If a company’s business is going in loss, you won’t receive any dividends and in case of bankruptcy equity shareholders’ capital is paid at the last (after paying other liabilities and preference shareholders capital).

Types of equity shares

Equity Share TypeDetails
Bonus sharesStocks that a company issues to the existing shareholders free of cost against the increased earnings from company business.
 Sometimes companies issue bonus shares in place of dividends
Right sharesThat a company offers its existing shareholders to purchase new shares at a specific price within a particular period before opened to public trading.
Voting sharesMost regular shares are voting shares because of your stake in the ownership of the company. 
Non-voting sharesSometimes companies can issue shares with the condition of no voting right to shareholders.
Sweat equity sharesCompanies often compensate their employees for better contributions in work by issuing sweat equity shares

Benefits of equity shares

  • Voting right in company’s business operations
  • Entitled to bonus share benefits
  • Existing shareholders can get benefit of getting right shares at discount

Cons of equity shares

  • Company is not bound to pay dividends
  • Risk of losing money

Also read – How to calculate intrinsic value of a share

What is Preference Share

A company can offer preference shares to get additional capital from the market to sustain its business operations or expansion of new business.

Preference shareholders get a fixed rate of dividends paid to them irrespective of whether the company’s business is profitable or at the loss. That means preference shares are protected from market volatility.

Secondly, if the company has not paid you the previous year’s dividends, they have to pay arrears on priority along with the present year’s dividends to the shareholders.

However, you don’t get any bonuses announced by the company because only equity shareholders are entitled to receive the bonuses.

Another thing that you may miss is voting rights. You also don’t have the voting rights to participate in the business decisions of the company.

Types of preference shares

Preference Share TypeDetails
Cumulative Preference Sharesin which if the dividends are not paid to the shareholders, are considered in arrears and are given priority over other dividend payments.
Non-cumulative Preference SharesYou are not compensated for unpaid dividends if a company skips the dividend payment in a particular time period.
Redeemable Preference SharesYou can redeem or the company can buy back redeemable preference shares in the future.
Irredeemable Preference SharesYou can’t redeem these shares in the future unless the company shuts its operations.
Convertible Preference SharesCan be converted into regular equity shares.
Non-convertible Preference SharesCan’t be converted into regular equity shares.
Participating Preference SharesYou get a chance to earn higher than the fixed dividend rate if company earnings increase.
Non-participating Preference SharesYou only enjoy fixed dividend rates

Benefits of preference shares

  • Fixed dividends that you get for sure
  • Company pays arrears on priority if previous dividends are not paid
  • Redeemable to equity shares
  • Preference of paying capital amount over equity shares if company bankrupts

Cons of equity shares

  • No voting rights
  • No access to bonus shares 
  • Chances of lower returns if company outperforms

Check out- How to calculate the fair value of share

Difference between Equity Share Vs Preference Share (in Table Form)

FactorsEquity SharesPreference Shares
DescriptionOrdinary share in which the company offers shareholders partial ownership in the businessA company offers a fixed amount of dividends to shareholders
Dividend payoutShareholders receive dividends if the company is earning profitsPreference shareholders are paid dividends on priority over equity shareholders whether the business is in profit or not.
Rate of dividendVariable as per earnings.Fixed
Bonus sharesShareholders are entitled to receive bonuses against the shares they own. No bonuses against existing shareholdings.
Repayment of capitalRepaid at the lastRepaid preferably before equity shares.
Voting rightsShareholders get the voting rights to participate in major business decisionsNo voting rights.
RedemptionNot availableAvailable
Arrears of dividendShareholders are not entitledShareholders have the right to get previous years’ arrears of dividends along with the current year’s dividends.
Share Typesan ordinary stock of a company.Several types –
Cumulative, & non-cumulative
Participatory & non-participatory, 
Convertible, & non-convertible, 
Redeemable, & Irredeemable
Investors TypeRisk-taking investors.It is suitable for risk-averse investors.

Also read – Lowest PE ratio stocks in India

Conclusion

You can opt to invest in Equity or Preference shares based on your interest areas and financial goals.

If you have confidence in a company and are inclined to take risks for a long-term investment, then you can buy equity shares which will help you earn better returns because most companies pay increased dividend rates based on their business performance.

But if you want a safer bet, then invest in preference shares where you get a fixed rate of dividends irrespective of how the company’s business performs. 

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