Understanding Preference Shares
Preference shares, often referred to as preferred stock, are unique shares in a company’s stock offerings. These shares come with the advantage of receiving dividends before common stock dividends are issued. Furthermore, in scenarios where the company enters bankruptcy, preference shareholders are prioritized in payments over common stockholders.
Unlike common stocks, which rarely have a fixed dividend, most preference shares guarantee a fixed dividend rate. However, preferred stockholders usually do not have voting rights, unlike their common stock counterparts.
Key Takeaways
- Preference shares (preferred stock) promise dividend payments to shareholders before any dividends are distributed to common stockholders.
- There exist four primary types of preferred stock: cumulative, non-cumulative, participating, and convertible.
- Preference shares are ideal investments for those seeking lower risk and steady dividends. They are also callable, meaning the issuer can redeem them anytime.
Inspiring Insights into Various Types of Preference Shares
Preference shares are categorized into four distinctive types: cumulative preferred stock, non-cumulative preferred stock, participating preferred stock, and convertible preferred stock.
1. Cumulative Preferred Stock
Cumulative preferred stock comes with a special provision: shareholders must be paid all dividends, including any that were omitted in previous periods, before dividends can be issued to common shareholders. Not all omitted dividends are paid on their due date; such unpaid dividends are known as “dividends in arrears” and must be given to the current stockholder when payment is eventually made. Occasionally, interest is also awarded to compensate the shareholder for the delayed payment.
Formula to calculate dividends would be:
Quarterly Dividend = [ (Dividend Rate) x (Par Value) ] ÷ 4
Cumulative Dividends per share = Quarterly Dividend x Number of Missed Payments
2. Non-Cumulative Preferred Stock
Shareholders of non-cumulative preferred stock do not benefit from retroactive dividend payments. If for any reason the issuing company does not pay dividends for a given year, those missed payments cannot be claimed in the future.
3. Participating Preferred Stock
Shareholders owning participating preferred stock have the unique right to dividends that add to the standard preferred dividends. This additional payout is typically contingent on a predefined corporate benchmark, such as exceptional profits. During liquidation events, shareholders can claim the purchasing price plus a proportional share of any remaining proceeds distributed to common stockholders.
4. Convertible Preferred Stock
Convertible preferred stock includes a conversion option, allowing the shareholder to convert their preferred shares into a predetermined number of common shares, sometimes influenced by the performance of the common stock. Additionally, this conversion can be called upon by either the issuer or the shareholder under predefined conditions.
What Are Preference Shares?
Preference shares, or preferred shares, provide a compelling hybrid between common stocks and fixed-income securities. They confer preferential treatment in the pay-out of dividends, but often do not allow the same degree of voting rights or participation in company equity increases as common shares do.
Navigating Bankruptcy with Preference Shares
If you own preference shares in a company that files for bankruptcy, the hierarchy of payments immobilizes preference shareholders over common stockholders but places them below fixed-income security holders like bondholders and debenture investors. This intermediate ranking grants a balanced risk-reward edge for preference shareholders.
Optimally structured preference shares provide certainty in uncertain financial climates, all while securing intermediate priority in distress scenarios. Investor resilience pairs seamlessly with preference reliability for a fortified financial portfolio. }
Related Terms: common stock, dividends, fixed-income securities, convertible bonds, corporate bonds.
References
- PWC. “7.7 Preferred Stock Dividends”.
- U.S. Securities and Exchange Commission. “What Are Stocks?”
