A zero-dividend preferred stock is issued by a company without the obligation to pay dividends to its holder. Investors in these shares can gain income from capital appreciation and may receive a one-time payment at the end of the investment period.
Key Insights
- Zero-dividend preferred stock does not offer dividend payouts.
- It retains priority over common stock in asset distribution and liquidation scenarios.
- Income predominantly comes from capital appreciation and could include a lump sum payment at maturity.
- Issuers favor this stock as it helps raise capital without diluting voting power and non-payment obligations.
- There are notable pros and cons for investors to consider.
Deep Dive into Zero-Dividend Preferred Stock
Companies typically issue two forms of stock: preferred and common. Preferred stock boasts a higher claim on dividends and assets, seen as less risky but typically without voting rights. Zero-dividend preferred shares don’t pay regular dividends but ensure repayment priority over common shareholders, especially if the issuer goes bankrupt, with reimbursed amounts pre-determined.
Similar to zero-coupon bonds but still positioned junior to them, zero-dividend preferred stocks hold preferential treatment over common stock during asset distribution. Often secured by the company’s assets, these stocks can play a vital role in split capital investment trusts aimed at generating fixed capital growth over a set term.
Rationale Behind Issuing Zero-Dividend Preferred Stock
Various organizations, particularly investment trusts, opt for zero-dividend preferred shares to alleviate long-term debt approval challenges. Issuing this stock facilitates raising capital beyond typical bank loan durations, unencumbered by restrictive bank loan conditions. The stock offers no dividend payouts or voting rights, rendering it an attractive instrument for companies to balance capital requirements and stockholder influence.
Weighing Advantages and Disadvantages of Zero-Dividend Preferred Stock
Benefits and Opportunities
- Tax Efficiency: The absence of regular dividends implies no usual tax liabilities. Any lump sum disbursed is taxed as a capital gain, generally at a lower rate than net income.
- Expected Return: An anticipated fixed return is established within a designated period, offering predictable yields.
- Reduced Volatility: Compared to common equities, these stock options tend to exhibit slower fluctuations, providing stability for investors.
Potential Drawbacks
- Sensitivity to Inflation: Whether bonds or preferred stocks, inflation impacts their value similarly.
- Market Dependent: Zero-dividend preferred stocks could underperform in a rising market environment.
- Risk of Devaluation: No yield guarantees exist, and underlying assets may lose value if market downturns occur.
Related Terms: preferred stock, dividend, capital appreciation, zero-coupon bonds, long-term investments.
References
- U.S. Securities and Exchange Commission. “Stocks”.
- Internal Revenue Service. “Topic No. 409 Capital Gains and Losses”.
