What are preference shares?
Preference shares or preferred stocks are the shares of a company’s stock that entitle its holders to receive dividends before the ones who own common stocks. Owning preference stocks will pay a fixed amount of dividends to the investors when the company is running on profit. In cases where the company is forced to shut down, the preferred shareholders have the right to claim their money from the company’s assets.
Preference shares are considered hybrid securities because their features are a combination of debt and equity investment. They can be converted to the desired number of common stocks, either with the approval of the board of directors or through a predetermined date allotted for the same.
Types of preferred shares
1.Cumulative preference shares: A preferred share is called cumulative because these shares guarantee its holders priority when the distribution of company stock dividends that have been missed in the past is carried out. The cumulative sum is called “dividend in arrears” and it goes to the owner of the stock at the time of its payment.
2.Non-cumulative preference shares: A non-cumulative preferred stock that does not pay its holders any dividends, unpaid or omitted. The dividends are issued at predetermined rates, paid out of the company’s net profit in a financial year. The shareholders enjoy the privilege of preference over equity shareholders.
3.Convertible preference shares: The shareholders receive a fixed dividend in return for their investment and they can be converted to equity shares after a set time or on a specified date. These kinds of shares ensure a stable income and return on invested capital. Converting them to common shares will help the holder ride the ride of an increase in share price. Thus, when investing in potential big winner stocks, they give high returns if the company performs well, and if it does not, the holder will have the fixed returns to benefit from.
4.Non-convertible shares: Non-convertible preferred stocks do not have the additional feature of being converted into common stocks. However, they also give a steady flow of income for the investor, similar to other preference shares.
5.Participating preference shares: These types of shares entitle the shareholder to enjoy the benefits of preferred shares as well as additional dividends. The additional dividend is paid to them in cases when the common shareholders receive more than a specified amount of dividend per share. Participating preference shareholders are paid before the common shareholders while issuing dividends. In case of liquidation of the company, they receive their original share price and also pro-rata share of the additional assets.
6.Non-participating preference shares: The shareholders of non-participating shares receive a fixed amount rate of dividend and have no claim over the additional shares. Thus, there is a limit set on the amount of dividend distributed for non-participating preferred shares.
7.Callable or redeemable preference shares: The type of preference shares that the company has the right to call in or repurchase from the shareholders after a specified period at a predetermined price. The company enjoys the benefit of getting financial security at the time of need while being able to buy the shares back after becoming stable financially. They are also called redeemable shares, having the features of both equity and debt financing.
8.Retractable preference shares: Contrary to callable shares, the retractable shares are the ones that let the shareholder sell his/her share back to the company at an agreed price. These shares have a maturity date, after which, the issuing company may pressure the shareholders into converting the shares into cash or common stocks. On maturing, the owner will receive the nominal value and the cumulative dividends on the stock.
How to buy Preference Stocks
Before deciding on which stock to invest in, pay close attention to the credit ratings of the options available. When choosing preferred stocks, choose the ones with high credit ratings as they are less risky investments. With the help of brokerage firms, you get an expert view on the potential of the stocks and allow you to open an account with a minimum balance. Analyse the performance of the stock closely before investing, decide on the number of shares that you are buying, and place the order.
Advantages and Disadvantages of Preferred stocks
As discussed earlier, owning preference stocks give you priority over the common stockholders in receiving dividends from the company’s profits and any other additional assets in case of any bankruptcy. Moreover, these stocks offer a guarantee of safety for cautious investors. They give higher returns compared with bonds. You will have a stable income from the fixed rate of the dividend when the company is in profit. The different types of preference shares give the investor options to choose from, according to their needs and preferences. In the case of convertible shares, they enjoy additional benefits of reaping in the profits of the climbing share prices.
The company also enjoys several advantages by issuing preference shares. One of them is the flexibility in issuing the dividends and at the same time, getting sufficient financial security for the smooth functioning of the company. Since the rate is fixed at the time of issuing the stock, the additional profit can be given to the common stockholders. The investors having preference stock do not have voting rights in any of the company’s decisions. It also reduces the debt to equity ratio of the company and increases its borrowing capacity, a characteristic of the leading company stocks.
1)How do you buy preference shares?
If you are thinking of investing in preference shares, here are the two ways you can purchase them: The preference shares are sold through the primary market. Primary markets are where the investor can buy the shares directly from the issuer. They can be purchased in the same way as common shares from a publicly-traded company. Secondary markets where the investors can buy or sell from one another. The secondary market trade can be on the exchange or over-the-counter. To buy them online, you must have a Demat account. You can also seek the help of brokers in the process.
2) What are the advantages of owning preference shares?
Preference shares give the investors a greater claim on the company’s profits and assets in case of liquidation or bankruptcy. Moreover, they are not subjected to the risk involved in trading common shares. Hence, preference shares are favored by investors who enjoy the protection that comes with investing in them.
3) What are the 8 types of preference shares?
The different types of shares include cumulative, non-cumulative, participating, non-participating, callable, retractable shares, convertible and non-convertible preference shares.
4) Why are preference shares unpopular?
They create an asymmetry in power relations due to the lack of voting rights for the preferred stock shareholders. Since they are not traded on the stock exchange, the price fluctuations do not affect them. The investor cannot bag in the profits caused due to an increase in shares trading in the market.
5) What happens if you own preference shares in a company that goes bankrupt?
In case of bankruptcy in a company one owns preference shares, the owners of preference shares are given priority over the common shareholders while giving out dividends. They also have right over the liquidation proceeds of its assets at its par value.
6) What is the preferred stock conversion ratio and how do you calculate it?
The number of a company’s preferred stocks that can be converted into common stocks. The par value of the preferred stock is taken in the calculation. It gives you a measure of the number of preferred stocks offered by a company.
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