Preference shares are often called "preferred stock." Preference shares are securities that represent ownership in a public company. They have some features of a bond and some features of common stock. Companies issue preference shares to raise money for growth. Should you buy preference shares?
Preference shares are a type of shares where dividends are paid out to shareholders before the issuance of common stock dividends. If a company goes bankrupt, preference shareholders have the first right over the company’s assets before common stockholders. Preference stockholders hold preferential rights over common stockholders when it comes to sharing gains and profits.
Features of preference shares
Preference shares have a special combination of features that differentiate them from equity shares or debt. Although the terms may change, the following characteristics are common:
- Preference shareholders have a priority over common shareholders to claim the company’s assets upon bankruptcy. They enjoy preferential rights of getting back capital in case the company decides to close its operations.
- Preference shares provide dividend payments to its shareholders. The dividend can be floating and vary with interest rate benchmark like LIBOR or it can be a fixed percentage that never varies.
- Preferred stockholders have a priority over common stockholders in dividend payments. The dividends paid are usually higher than the interest paid on the bonds.
- Usually, preference shareholders don't have voting rights in any business proceedings.
- Preference shares can be repurchased by the company at a specific price on a specific date.
- Preference shares may be converted to common shares depending on a pre-determined number. Some of the preference shares mention the date at which the shares can be converted, while others need a board of director's approval.
Types of preference shares
There are five types of preference shares:
- Cumulative preference shares have a provision requiring the issuer to pay all dividends to shareholders, including those that were missed in the past, before common stockholders get their dividend payments.
- Non-cumulative preference shares don’t issue any missed dividend payments. These stockholders are eligible to be paid dividends only from the net profit of each year. These types of shareholders can’t claim any forgone dividends at any time in the future.
- Participating preference shareholders receive a pre-determined rate of dividend and also an additional dividend based on a defined condition.
- Convertible preference shares can be converted into common shares based on a set number. Usually, shares are converted at any time after the pre-determined date. In normal circumstances, on request of the shareholder, convertible preferred shares are converted into common stock.
- Callable preference shares can be repurchased by the issuing company at a specific price on a certain date.
Should you buy preference shares?
Investors should consider buying preference shares if they need a steady flow of income. You should think about buying preference shares when the rate of interest is lower. Preference shares are usually less volatile than common stocks and are best suitable for risk-averse equity investors.