Overview

When it comes to investing in the stock market, many investors often think of common shares. However, there is another type of share that is becoming increasingly popular: preference shares.

These shares offer unique benefits and advantages that make them an attractive option for investors seeking stable and reliable returns.

Unlike common shares, these shares have specific features that make them stand out in terms of risk and reward.

From their potential for a steady income to their priority status in the event of bankruptcy, there are a variety of reasons why preference shares might be worth considering for any investment strategy.

What Are Preference Shares?

Also known as Preferred Stock, these are a type of security that companies can issue to investors which typically comes with certain rights and privileges. This difference between preferred stock and common stock makes them more appealing to investors.

Here we’ll explore types of preferred stock and how they work.

• Preferred Stock

  Preferred stock is a type of security that represents ownership in a company. However, unlike common stock, preferred stockholders have certain rights and privileges that make their investment less risky.

  As per the preference shares definition, holders of these stocks typically receive a fixed dividend payment, which means they are guaranteed a certain amount of income regardless of how the company performs.

  Additionally, in the event of bankruptcy, preferred stockholders are typically paid out before common stockholders.

• Preferred Stock Shareholders

  Preferred stock shareholders have certain rights and privileges that make their investment less risky. For example, preferred stockholders typically have a higher claim on the company’s assets and earnings than common stockholders.

  Additionally, preferred stockholders may have the right to vote on certain matters, such as changes to the company’s charter or the issuance of additional preferred stock.

Understanding Preference Shares

According to the preference shares definition, these shares are a unique class of shares that offer certain advantages to investors. These advantages include a fixed dividend rate, priority in receiving dividends, and priority in receiving payments in the event of liquidation.

Such shares are an important source of capital for companies, as they offer a way to raise funds without diluting the ownership of existing shareholders.

• Cumulative Preferred Stock

  One type of preference share is known as cumulative preferred stock. This type of share comes with a guarantee that all missed dividend payments will be paid out to shareholders before any common shareholders receive any dividends.

  This can be an attractive option for investors who are looking for a steady income stream, as they can rely on receiving their dividend payments even if the company runs into financial difficulties.

• Participating Preferred Stock

  Another type of preference share is participating preferred stock. With this type of share, the investor receives a fixed dividend rate but also has the potential to receive additional dividends if the company’s profits exceed a certain threshold.

  This can be a good option for investors who are looking for a way to participate in the company’s success while still receiving a steady income stream.

• Convertible Preferred Stock

  Finally, there is convertible preferred stock. This type of share allows the investor to convert shares of their preference stock into common shares at a certain point in time.

  This can be an attractive option for investors who believe that the company has strong growth potential, as it allows them to participate in the company’s success in a more direct way.

What Are The Main Types Of Preference Shares?

These shares are a popular choice for investors seeking stable returns and a degree of safety. These shares offer unique features that distinguish them from common shares and make them attractive to investors.

There are several types of preferred stock that investors can choose from based on their investment objectives and risk tolerance.

• Convertible Preference Shares

  Convertible preference shares are a hybrid of debt and equity.

  These shares can be converted into common shares at a predetermined price, providing the investor with the opportunity to participate in the company’s growth potential.

  It provides the benefit of fixed income while also offering the potential for capital appreciation.

• Non-Convertible Preference Shares

  Non-convertible preference shares do not offer the same conversion option as their convertible counterparts.

  Instead, another difference between preferred stock and common stock, preferred stocks offer a fixed dividend payment that is typically higher than that of common shares.

  These shares are typically less risky than common shares but offer less potential for capital appreciation.

• Redeemable Preference Shares

  Redeemable preference shares are those that can be redeemed by the issuing company at a predetermined price after a specific period.

  These shares provide the investor with a degree of safety as they can be redeemed for a fixed price, ensuring that the investor receives their investment back.

• Non-Redeemable Preference Shares

  Non-redeemable preference shares do not offer the same redemption option as their redeemable counterpart.

  These shares provide the investor with a stable income stream but do not guarantee a return on the principal investment.

• Participating Preference Shares

  Participating preference shares offer the investor the right to participate in the company’s profits beyond the fixed dividend payment.

  These shares provide the investor with the potential for higher returns than non-participating shares.

• Non-Participating Preference Shares

  Non-participating preference shares do not offer the same profit-sharing option as their participating counterparts.

  These shares provide a fixed dividend payment that is typically higher than that of common shares.

• Cumulative Preference Shares

  Cumulative preference shares provide the investor with the guarantee that if the company fails to pay the dividend in any year, the unpaid dividends will accumulate and be paid in the future before any dividends are paid to common shareholders.

• Non-Cumulative Preference Shares

  Non-cumulative preference shares do not offer the same dividend accumulation option as the cumulative type.

  These shares provide the investor with a fixed dividend payment that is not guaranteed if the company fails to pay the dividend.

• Adjustable Preference Shares

  Adjustable preference shares offer the company the option to adjust the dividend payment based on changes in the company’s financial performance or other predetermined criteria.

  These shares provide the investor with a degree of flexibility as the dividend payment may increase or decrease depending on the company’s performance.

What Happens If You Own Preference Shares In A Company That Goes Bankrupt?

If an investor owns preferred stock in a company that goes bankrupt, he or she may be wondering what will happen to their investment. So, let’s have a look at such a scenario.

• Rights Of Preference Shareholders

  These shares are a type of equity security that gives investors a priority claim to the company’s assets and income over common stockholders.

  However, in the event of bankruptcy, there may not be enough assets left to pay off all of the company’s creditors, including preference shareholders.

• Dividends

  Typically, preference shareholders are entitled to receive a fixed dividend payment before common shareholders receive any dividends.

  However, if the company is unable to pay these dividends due to financial difficulties or bankruptcy, the preference shareholders may not receive any payment at all.

• Priority Of Claims

  In the event of bankruptcy, preference shareholders are considered senior to common shareholders but junior to debt holders, such as bondholders or banks.

  This means that preference shareholders may receive some proceeds from the liquidation of the company’s assets, but only after all debt holders have been paid off.

Features Of Preference Shares

These shares offer investors a unique set of features and benefits who are primarily interested in income and downside protection. Let’s explore some of those features in more detail.

• They Can Be Converted Into Common Stock

  One of the main features of such shares is that they can be converted into common stock at a predetermined ratio.

  This means that if the company’s share price rises above a certain level, preference shareholders can convert their shares into common stock and benefit from any potential gains.

  This feature is attractive to investors who want to participate in the upside potential of a company’s common stock, while also maintaining some degree of protection against downside risk.

• Dividend Payouts

  Shares of preferred stock also offer investors the benefit of regular dividend payments. These dividends are typically fixed at a specific rate, which is determined at the time the shares are issued.

  This fixed dividend payment gives preference shareholders a reliable source of income, which is especially attractive to income-oriented investors.

• Dividend Preference

  In addition to regular dividend payments, preference shareholders also have a preference when it comes to dividend payouts.

  This means that if a company experiences financial difficulties and is forced to reduce or suspend dividend payments; preference shareholders will be paid their dividends before common shareholders.

  This gives preference shareholders a higher degree of protection against the downside risk of investing in a company.

• Voting Rights

  These shares typically do not come with voting rights, which means that preference shareholders do not have the ability to vote on matters related to the company’s governance.

  This feature is attractive to investors who are primarily interested in the income potential of their investment, rather than having a say in the company’s decision-making process.

• Preference In Assets

  Finally, preference shareholders also have a preference when it comes to the company’s assets in the event of liquidation.

  If a company is forced to liquidate its assets, preference shareholders will be paid back their investment before common shareholders.

  This gives preference shareholders a higher degree of protection against the downside risk of investing in a company.

Final Thoughts

Preference shares are a unique investment opportunity that combines the benefits of both equity and debt.

They offer investors a fixed dividend payment, priority over common shareholders in case of liquidation, and the potential for capital appreciation.

These features make these shares an attractive option for investors who seek stable returns and want to mitigate risk.

Additionally, these shares are a valuable tool for companies seeking to raise capital without diluting ownership or taking on more debt.

Overall, these shares are a versatile investment vehicle that can offer both investors and companies a range of benefits, making them an excellent addition to any investment portfolio.

FAQs

What Are Redeemable And Non-Redeemable Preference Shares?

Redeemable preference shares allow the issuing company to buy back the shares at a future date, while non-redeemable preference shares cannot be repurchased by the company.

This key difference affects the level of risk and potential return for investors.

How Can Preference Shares Be Converted Into Common Stock?

Preference shares can be converted into common stock through a process known as conversion.

This allows investors to exchange their preferred stock for a predetermined number of common shares, providing greater flexibility and potential for increased returns.

Conversion is typically initiated by the investor and requires adherence to certain terms and conditions established by the issuing company.

Who Buys Preference Shares?

Preference shares are typically purchased by investors seeking a combination of a steady income and reduced risk. These shares often offer fixed dividends and priority over common stock in the event of bankruptcy or liquidation.

Investors who prioritize stability over growth may find preferred stock to be a suitable addition to their investment portfolios.