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Preferred shares are a type of company stock that pays investors a fixed dividend and places them ahead of common shareholders in dividend payments. In contrast to ordinary shareholders, preferred shareholders typically do not enjoy voting privileges, yet they receive more secure returns and lower risk. Preferred shares are best for those seeking stable dividend income without relying on stock price appreciation. In the event of liquidation, preferred shares are given priority over common shares, making them a safer and more certain investment in the share market.
Key Takeaways
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Preferred shares offer a fixed dividend and precedence over common shareholders, making them ideal for risk-averse investors.
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There are several types - cumulative, non-cumulative, participating, convertible preferred shares and more.
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Cumulative shares ensure that any missed dividends are paid in the future, whereas non-cumulative shares do not carry forward unpaid dividends.
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Preferred shareholders are paid before common shareholders but after debt holders, such as bondholders, in case of bankruptcy.
What is Preference Share?
Preference shares are equity shares that receive priority in dividend payments over ordinary equity shares. Preferred stock or preference shares entitle their holders to receive dividend payments before common shareholders when the company declares dividends. Preference shares can also be defined as equity holdings that give shareholders the right to claim dividends throughout the company's operational life. If the company underperforms and liquidates, preference shareholders are also eligible to claim repayment of capital before common shareholders.
Types of Preference Shares
Preference Shares in India come in various forms, and each type provides distinct features and advantages to investors. The shares vary based on how dividends are paid, redeemed, or converted.
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Cumulative Preference Shares: The unpaid dividends are rolled over and paid later.
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Non-Cumulative Preference Shares: Dividends are payable only from the profits of the current year.
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Redeemable Preference Shares: Company can repurchase shares after a specified period.
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Irredeemable Preference Shares: Cannot be redeemed during the company's lifetime; only redeemed when the company winds up.
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Participating Preference Shares: Receive fixed and additional dividends and surplus profit.
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Non-Participating Preference Shares: Receive only fixed dividends.
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Convertible Preference Shares: Can be converted into common stock.
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Non-Convertible Preference Shares: Cannot be converted into common stock.
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Callable Preference Shares: Company can buy them back at a predetermined price.
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Adjustable-Rate Preference Shares: Dividend varies with the market interest rates.
Preferred Stock Example
We can also define preferred stock through an illustration of how it works. As an example, suppose that a Company ‘C’ has a total of 10,000 preference shares to distribute among its investors. These shares are priced at ₹100, with a dividend rate of 8% per annum. For the years 2018 and 2019, C company has not paid dividends to its preference shareholders.
In 2020, before the company can pay its common shareholders , the preference shareholders are eligible to receive ₹2,40,000 in cumulative dividends. This amount represents the cumulative dividend for all preference shareholders over 3 years (2018, 2019, and 2020). Preference shareholders will get priority before other shareholders when the company starts paying its dividends.
Preferred Shares Features
Preference shares differ from common equity or debt along the following lines.
Dividend Preference: With preference share, shareholders get the benefit of receiving the dividend payment on priority relative to non-preference stockholders.
Voting Rights: Generally, one does not get voting rights in the company’s management when they buy stock in the company. However, in certain extraordinary cases, preference shareholders can receive the right to vote.
Preference in assets: In case the company liquidates, preference shareholders also get priority over a company’s assets and can claim them over non-preference shareholders.
Convertibility: Preference shares have the option of being converted into a predetermined number of non-preference shares. If an investor wishes to alter their holding position, they have this option. Depending upon the company, preferred stock has the option to be converted prior to a specific date or might require the permission of the board of directors.
Callability: At some point in the foreseeable future, an issuer can repurchase their preference shares through a callback. This scalability is similar to being converted into a non-preference share. However, when the preference share is repurchased by the company itself, the company’s ownership is increasing as opposed to third party investors.
Preference Shares Benefits
Preference stock offers advantages to both its stockholders and the issuer. These advantages are divided into both these categories.
When it comes to the benefits offered to an investor, preferred stock helps as follows:
Secured position: When compared to common shareholders, those with preferred stock have a significantly more secure position. They can claim the company’s assets first in case of the company’s liquidation.
Fixed income: Depending on the company and the type of preference share chosen, investors receive a fixed passive income through regular dividend payouts.
Preferred stocks offer the issuer the following benefits:
Flexibility: The management and board of directors of a company also enjoy flexibility in setting up the use of preferred stock in the way in which they see fit. They can allocate the ratio of preference shares most suited to their company to attract investors.
No dividend obligation: A certain type of preferred stock known as cumulative preferred stock affords the issuer the freedom to defer investors’ dividend payouts. This helps the investor when they lack sufficient dividend funds. This policy allows the company to defer dividend payments until funds are available, rather than being obligated to pay immediately.
Also, Read When are Stock Dividends Paid Out here
Conclusion
If you're an investor who values steady income and stability more than corporate control, preference shares might be perfect for you. They usually don't offer voting rights, but they do offer fixed and consistent payments. Beyond just knowing what a preference share is, it's vital to understand the key variations, such as cumulative, non-cumulative, participating, convertible, and redeemable preference shares.
Another important aspect is knowing the features of preference shares. Preference shareholders get priority when it comes to receiving dividends and recovering company assets if the firm is liquidated. Some preference shares allow companies to defer dividend payments until they're financially stable, which can benefit both the company and long-term shareholders.
Platforms like Angel One make it easy for investors to explore and invest in various types of preference shares. By understanding the features of preference shares and how each type works, investors can make informed decisions.
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