When it comes to investments in shares, the type of share that first hits our minds is equity shares. However, other than equity shares, another popular type of share is preference shares.
They appeal to different category of investors. Exploring this article would help you, as it covers the meaning and characteristics, types, advantages and risks, and whether you should invest in them.
What Are Preference Shares?
Preference shares, also known as preferred stocks, possess features of equity and debt securities. They are similar to equity shares in that they represent partial ownership and are traded on the stock exchange. Like debt securities, they regularly pay dividends at a fixed rate to preference shareholders. Therefore, they are considered hybrid securities.
Characteristics Of Preference Shares
Preferential rights
Preference shareholders get priority over common stockholders regarding dividend payment and repayment in case of company liquidation.
Voting rights
However, they don’t possess voting rights and therefore do not have much say in company matters.
Dividend payout
These shares usually offer fixed dividends to the holders.
Types Of Preference Shares
Cumulative preference shares
The dividend is a part of the profit, and there are chances that a company may not mark profit in some years. Cumulative shares require the companies to pay cumulative dividends in the coming year when they incur profit in case there are any unpaid dividends.
Non-cumulative preference shares
In the case of non-cumulative shares, the shareholders do not get accumulated outstanding dividends for the years when there are insufficient profits. In other words, the investors only get dividends for those years when the company records profits.
Convertible preference shares
Convertible shares are those in which the holder gets the right to convert them into equity shares after a specific time period mentioned in the memorandum.
Non-convertible preference shares
Non-convertible shares are those in which the holder does not get the right to convert them into equity shares. As preference shareholders, they get preference in dividend payments and repayments in case of company liquidation.
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Participating preference shares
Preference shareholders usually get a fixed rate of dividends. However, participating preference shares offer additional benefits. If the company marks extraordinary earnings, these shareholders get the opportunity to earn from extra profits, in addition to a fixed dividend, after other shareholders are paid.
Plus, in case of company liquidation, they get the right to earn from the profits after the rest shareholders are paid.
Non-participating preference shares
As the name suggests, shareholders owning these shares do not enjoy the right to participate in extra profits and only get fixed dividends.
Advantages Of Preference Shares
Advantages to investors
- Preference shareholders earn fixed dividends and may also benefit from capital appreciation.
- Preference shareholders enjoy preference over equity shareholders for dividend payments.
- Preference shareholders have the right to claim the company’s assets before equity shareholders in case of company liquidation, which makes it a less risky investment than equity.
Advantages to issuing company
- The cost of these shares may be less than equity shares.
- The company can preserve voting rights by issuing preference shares.
Risks Associated With Preference Shares
- Market risk: The value of these shares can decrease in unfavourable market conditions.
- Interest rate risk: If the prevailing interest rate in the market increases, the demands for these shares are likely to decrease, resulting in a reduction in market prices.
- Liquidation risk: Though preference shares have lesser liquidation risk than equity shares, the risk is still there. Preference shareholders can only claim assets remaining after creditors and bondholders/debenture holders are paid in case of liquidation.
How To Buy Preference Shares?
- You may buy the shares directly from the issuing company when it first issues them in the primary market.
- As these shares are also traded on the stock exchanges, it is possible to buy them from other investors through the secondary market.
Should You Consider Investing In Preference Shares?
Whether you should go for preference shares, depend on your investment objective. You may find these shares suitable if you want consistent returns and benefit from capital appreciation at a lesser risk than equity shares.
If you want to earn greater returns and don’t mind extra risk coming along with it, you may find equity shares a better option over preference shares. You may also consider having a mixture of both to balance the risk and returns.
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FAQs
Preference shares usually offer fixed dividends. Plus, preference shareholders enjoy priority over equity shareholders in events of dividend payments and repayment in case of company liquidation.
Investors looking for predictable but better returns than fixed-income securities like bonds and debentures and a less risky financial instrument than equity may like to own.
Preference shares are traded on the stock exchange, so it is possible to sell them to other investors. The company may repurchase them in the case of redeemable shares.
The market price of preference shares may increase when the interest rate in the market falls.
Yes, the preference shareholders usually get fixed dividends, and that too before equity shareholders.
