When it comes to trading in the stock market, the Preference Shares shine like a pole star. Why? You may wonder. Because they give you special perks that make you feel like a VIP investor. With preference shares, you get fixed dividends before regular shareholders, ensuring a steady stream of income.
Let me explain it in simple terms. Imagine a scenario when common shareholders wait for their dividends. But you, as a preference shareholder, get the dividends first and that too at a fixed rate! When the financial condition of a company destabilizes, you’ll be the first to be rescued. Also, you’ll get back some of your invested money.
That sounds way more safe and profitable from the perspective of an investor. Isn’t it? So, if you want stability and priority treatment, preference shares are perfect for you!
Now, your mind must be hovering with questions like these-
What are they? How many types of preference shares are there? Is it more expensive than equity shares? What is the difference between preference shares and equity shares?
Worry not! You will get answers to all these questions in this article below.
What are Preference Shares?
As the term suggests “Preference Shares” are a special type of ownership in a company. It gives shareholders certain preferential rights and benefits over common shareholders. These shares typically carry specific rights and privileges, making them different from ordinary shares.
For instance, if a company goes into liquidation, being a preferred shareholder you can claim the remaining assets. And that too before the common stockholders receive their shares.
That’s not all but you will get other significant benefits too. These shares represent a hybrid between common stocks and bonds, combining characteristics of both equity and debt instruments.
They offer preferential rights to the “preference shareholders” when it comes to the distribution of dividends/liquidation of a company.
(A) The Objective of Preference Shares
The prime objective of releasing the preference shares is to raise capital for the company. This is known as “Preference Share Capital.”
Unlike equity shares, preference shares are void of voting rights. Therefore, if the board members make any announcement about the preferred stock’s dividends, you need to follow it.
(B) Who is suitable for investing in Preference Shares?
The preference shares are suitable for-
- Big investors
- Risk-averse investors
- The investors who wish to stay in the market for a long time.
Preference Shares vs Equity Shares
Look at the table given below to understand the differences between preference shares and equity shares-
| Particulars | Preference Shares (Preference Stock) | Equity Shares (Common Stock) |
| Investment Risk | Moderate | High (Less guarantee of safety and possess a risk of loss if a company fails) |
| Cost | Expensive | Comparatively affordable |
| Voting Rights | Absent | Present |
| Volatility | Low | High |
| Dividends | Fixed and Cumulative Dividends (the dividends tend to increase) | Dividends fluctuate based on the performance & profitability of the company |
| Dividends Payment Order | After debt holders | Paid out at last |
| Board Members impacting the dividend | No | Yes (Equity shareholders can avail of dividends at the discretion of the board) |
| Firm’s obligation to pay dividends | Obliged | Not obliged to pay dividends to common stockholders |
| Liquidation | Higher claim on a company’s profits and assets | Less claim on a company’s profits and assets |
| Conversion | Can be converted into common stock (equity shares) | Cannot be converted into preference stock (preference shares) |
| Returns | Depending on the dividends | Depend on the appreciation/depreciation of the share price and optional dividend. |
| Growth | Don’t grow as the company grows | Directly connected to the company’s growth |
From the above table, it is clear that Preference shares outshine the equity shares. But still, the majority of folks prefer equity shares. Don’t you wonder why? The prime reasons are the affordability, voting rights, and direct connection of equity shares with the company’s growth! The expensive price range of preference shares makes them accessible only to medium to large investors.
If getting returns on investment is your first priority then undoubtedly you must go for Preference Shares despite its expensive price. Why? Because of its immense benefits. In the upcoming sections, we will describe the benefits of preference shares.
But before that let’s explore the different types of preference shares in the next section.
Types of Preference Shares
The preference shares are classified into eight types. How? Based on the differences in the process, dividend pay-outs, maturity period, and participation of shareholders.
Let’s look at the types of preference shares that will determine your dividend payouts-
1. Cumulative Preference Shares
The term “Cumulative” means accumulating or aggregating. So, if you are a holder of cumulative preference shares. Then, you are entitled to receive unpaid dividends from previous years. Suppose a company doesn’t pay any dividends in the current year and decides to offer dividends in the next year. Then you will receive both dividends together in the upcoming year.
Here, the pending dividends are paid first to the cumulative preference shareholders. And then the dividends are paid to common shareholders.
2. Non-Cumulative Shares
Unlike Cumulative preference shares, you won’t receive any unpaid dividends. Here, the unpaid dividends aren’t accumulated. Therefore, if the company skips paying dividends in a particular year. You won’t have the right to claim those dividends in the future.
3. Convertible Preference Shares
This type is also an advantageous feature of preference shares. How? Because of its convertibility feature. Here, you get the option to convert the preferred shares into a specified number of common shares. But you can convert it only at a predetermined conversion ratio.
How is it beneficial for the shareholder? If they needed common shares, why don’t they purchase it separately? See, time and the perfect moment are crucial in the stock market. Also, the preference shares aren’t directly connected with the company’s growth.
So if a company grows rapidly increasing the price of common/equity shares and you wish to benefit from it. Then, you can convert a specific portion of preference shares into common shares. Thus, convertible preference shares are highly advantageous for shareholders.
4. Non-Convertible Preference Shares
It is the exact opposite of the above type. Here, you don’t have the option to convert the preference shares into common/equity shares. You will receive fixed dividends and won’t be able to participate in any appreciated stock value of the company.
5. Redeemable Preference Shares
You can call it “Callable Preferred Stock.” It is the most impactful method of raising capital. Therefore, numerous big companies adopt it.
Redeemable preference shares have a fixed maturity date. The company has an obligation to repurchase them from the shareholders at a specific price on or after the redemption date.
This feature provides investors with the ability to exit their investments after a certain period. It is a sandbox for companies to combat inflation and the decline of the monetary rate.
6. Irredeemable Preference Shares
Irredeemable preference shares, as the name suggests, do not have a fixed maturity date. The company is not obligated to repurchase them from the shareholders. The shareholders continue to hold these shares until the company winds up its current operations or liquidates the venture entirely.
It is a perpetual liability for the company as well as the investors.
7. Participating Preference Shares
If you are looking for a preference share that provides the greatest potential for higher returns. Then you can go for the Participating Preference Shares! Here, you are entitled to receive both fixed dividends and additional dividends.
What are additional dividends? You may ask. These are the share of the company’s profits distributed after paying dividends to common shareholders. This type of preference share provides greater potential for higher returns.
8. Non-Participating Preference Shares
Contrary to the above, you are not entitled to receive any extra dividends in the Non-participating preference shares. You will only receive fixed dividends!
You can’t participate in any additional dividends beyond their predetermined rate. They are limited to the fixed dividend, irrespective of the company’s overall profitability.
9. Adjustable-rate Preference Shares
The prevailing rates in the market determines the rate of dividend. You can say that the stock market influences the amount of dividend that you will receive in this investment. That’s why you call it adjustable-rate preference shares because it changes as per the stock market conditions.
Thus, these types of Preference Shares offer certain preferential rights over common shareholders. These shares typically carry specific rights and privileges, making them different from ordinary shares.
Benefits
By now you might have got a rough idea about how beneficial the preference shares are! In this section, we will describe the major benefits of preference shares-
- Priority in Dividends: You receive dividends before common shareholders. Thus, it ensures a consistent income stream.
- Capital Protection: The fixed dividend rate provides stability and a degree of capital protection.
- Conversion Option: For convertible preference shareholders, the ability to convert into common shares offers the potential for capital appreciation.
- Attracting Investors: Issuing preference shares can attract investors who prefer a lower-risk investment option with predictable returns.
Conclusion
The different types of preference shares provide a flexible and diverse set of options for both companies and investors. The former seeks capital while the latter seeks low-risk and high-return profiles.
You get a diverse range of advantages in preference shares like cumulative dividends and convertible shares. Apart from that you will also receive additional dividends in Participating Preferred Shares. Although you won’t have any voting rights you’ll have a high ROI.
However, it’s essential to carefully consider the terms and conditions associated with each type of preference share before making any investment decisions.
Nice article! I’ve heard about preference shares before but got a clearer idea about through this article.