Preferred shares sit between regular stocks and bonds, providing firms and their investors with ample benefits. The distribution of these shares is much higher than common stocks. Their popularity is because only preferred shareholders own this particular stock. Companies can raise more capital using preferred shares because some investors demand more regular dividends and better bankruptcy protections than common shares provide.
As the global bear market continues, more and more investors are turning to preferred stock for high long-term returns while more and more companies are launching different types of preferred stock on the market.
What Are Preference Shares?
The preference share definition states that these are stocks that allow the owners to receive dividends declared by the company before common stockholders. Therefore, if someone has a preference share in Company X, they will get the dividend first, and the general shareholders will get it later.
Preference shares are issued to raise money for the company and are referred to as preference share capital. When the company decides to file for bankruptcy or simply shut shop, preference shareholders are paid first, followed by stockholders. Preference shares in India must be redeemed within 20 years of the issuance and are referred to as redeemable preference shares. Companies in India are not allowed to issue irredeemable preference shares under the Companies Act 2013.
Types of Preference Shares
The following are the nine types of preference shares:
1. Convertible Preference Shares: Convertible preference shares can readily be converted into equity shares.
2. Non-Convertible Preference Shares: Non-convertible preference shares cannot be converted into common shares.
3. Redeemable Preference Shares: You can redeem or repurchase this preference share type from the issuing company at a specified price and date. This stock benefits the company by serving as a buffer against inflation.
4. Non-Redeemable Preference Shares: Non-redeemable preference shares are advantageous for companies because they act as lifelines against inflation. You cannot repurchase these shares from the issuing company at a specified date.
5. Participating Preference Shares: These shares enable shareholders to claim a portion of the company's excess earnings after dividends are paid to other shareholders at the time of liquidation. However, these shareholders receive a fixed dividend and participate in the company's surplus with the holders of the shares.
6. Non-Participating Preference Shares: These shares do not offer the owners the opportunity to receive dividends from the company's surplus profits, but they do receive fixed dividends from the company.
7. Cumulative Preference Shares: Cumulative preference shares give owners the right to receive cumulative dividends from the company, even if it is not profitable. These dividends are arrears in years when the company is not profitable and are paid in full in the following year when the company is profitable.
8. Non-Cumulative Preference Shares: In the case of non-cumulative preference shares, investors cannot collect dividends in the form of arrears. Dividends are paid out of the company's profits for the current year. Therefore, if a company does not profit in a year, shareholders will not receive a dividend for that year, nor can they receive dividends on future profits or years.
9. Adjustable Preference Shares: The dividend rate for adjustable preference shares is not fixed and changes as per current market rates.
Features of Preference Shares
Several features of preference shares have led ordinary investors to achieve exceptional returns even during a sluggish economic performance. The following are the most attractive features of preference shares.
● Dividend payouts: Preference shares allow owners to receive dividend distributions, while other shareholders may receive dividends later or not at all.
● Asset preferences: Considering a company's assets during liquidation, preferred shareholders have priority over non-preferred shareholders. The "preference share" meaning is reflected in the term itself, as the shareholder gets preferential treatment.
● They are convertible into common stock: Preference shares are easily convertible into common stock. If a shareholder wishes to change their holdings, the set of shares is converted into a certain number of preferred shares. Some companies that offer preferred shares advise investors that the shares can be converted after a certain date, while others may require approval and consent from the company's board of directors before conversion.
● Voting rights: Preference shareholders can vote on specific events, such as any resolution to be taken by the company. However, this is only possible in a small percentage of cases. Generally, the purchase of shares in a company does not confer voting rights in the company's management.
Why Should You Consider Investing in Preference Shares?
There are several reasons why certain stocks are preferred over others. If you are an investor and choose to invest in these stocks, it is a great way to future-proof your investment and reap the benefits of preference shares.
For example, if the company files for bankruptcy, all preferred stockholders will have the first and privileged access to the assets under the hatchet. Such benefits certainly incentivize people with a low-risk appetite to invest at certain times. Moreover, if the company's regular stock performs exceptionally well, holders of preferred stock can convert portions of their holdings into common stock and profit.
Furthermore, the preference share definition means that investors can repurchase the shares whenever they want. Thus, preferred stock is a fantastic benefit offered by the company.
What are the risks associated with these Preference Shares?
Like other financial products, these shares also involve certain risks. In times of significant market volatility, there is uncertainty about how much dividend the stock will generate. Those with a lower risk tolerance may not want to take too many risks with this particular investment opportunity. In addition, some preference shares may initially offer higher yields because they are tied to PAT (after-tax earnings). However, the associated risks can be significant.
These shares are typically issued by companies with substantial market capitalizations and can pay high dividends to a broad subscriber base over a long period. While this may appear to be a risk-mitigating element, it can be quite effective in practice.
Preference shares are an excellent way to build a respectable reputation among a company's shareholders. If the company is careful about the liquidity of the shares, preference shareholders have a significant advantage when it comes to claiming dividend payments. Issuers may also set their terms for preferred shareholders, with some granting voting rights to holders in exceptional cases.
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Frequently Asked Questions
Redeemable preference shares can be repurchased by the issuing company at a specified price and date. This stock benefits the company by serving as a buffer during inflation.
The issuing company cannot repurchase non-redeemable preference shares within a certain period. Non-redeemable preferred shares benefit companies because they act as lifelines against inflation.
If a shareholder wishes to change his participation position, the preference shares are converted into a certain number of preference stocks. Some preference shares advise the investor that they may be converted after a certain date, while others may require approval and consent of the Company's Board of Directors before conversion.