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Preference shares are a special type of stock which gives the shareholders priority when it comes to dividend payments. However, they are typically issued via private placement, though some are listed on exchanges. In this article we cover what is preference share, characteristics, and how they work. By being aware of its advantages and disadvantages one can make better informed decisions.
Preferred stock (or preference shares) are financial instruments that combine debt and equity features. These stocks are part of a hybrid category of securities. Investors who purchase these stocks get ownership in a company, their structured, fixed-income nature makes their behaviour more similar to bonds than common stock.
Since preference shares combine the characteristics of a debt or equity security. The key preference shares features are:
There are different preference shares one can invest in; common types include:
Preference Share Types
Description
Cumulative Preference Shares
These shares allow shareholders to receive all the pending dividends that have not been paid by the company in any of the previous years. This applies when the company fails to earn profits and cannot pay dividends to preference shareholders, dividends accumulate (for cumulative shares) but are not guaranteed
Non – Cumulative Preference Shares
This type of preference shares allows shareholders to receive dividends before common shareholders. The dividend payout must only be through the company’s annual profit.
Redeemable Preference Shares
These shares come with a specified redemption price and date when the companies can buy back the preferred stock.
Irredeemable Preference Shares
These shares are also called perpetual preference shares; companies can only repurchase these shares during the company’s liquidation or if it permanently shuts down its operations.
Participating Preference Shares
These shares provide the shareholders the right to receive extra dividends in addition to their fixed dividend amount. The extra dividends are generally provided through the company’s profit above a certain amount.
Non – Participating Preference Shares
Shareholders of these shares receive a fixed dividend amount irrespective of the company’s financial performance.
Convertible Preference Shares
These preferred stocks allow shareholders to convert their holding shares into equity shares of the company. This gives the investor fixed dividend payments along with the opportunity for capital gains.
Non – convertible Preference Shares
These types of shares do not give the shareholders the option to convert them into common stocks. They only offer fixed dividend payments.
Adjustable-rate Preference Shares
The dividend rate is not fixed for these types of shares and changes based on the prevailing market interest rates. Helps reduce interest rate risk.
Preference shares with a callable option
Callable preference shares are the type of preference shares that a company can buy back or call in at a set date and at a specific price. Both the date and price are mentioned in the company’s prospectus for the investor.
When it comes to investing in preference shares, one of the vital decisions the choice between cumulative preference share and a non-cumulative preference. Both the types of shares differ in how you will receive dividends. The following table lists the main distinctions:
Aspect
Non-Cumulative Preference Shares
Dividend Treatment
Unpaid dividends accumulate and must be paid before common shareholders.
Unpaid dividends are forfeited if not declared in that year.
Dividend Priority
Arrears are paid first, then current dividends, ahead of equity dividends.
Only current year’s dividend prioritized no arrears recovery.
Investor Assurance
Guaranteed eventual payment of all due dividends.
Missed dividends are lost permanently.
Suitability
Income-focused investors who are seeking steady returns.
Risk-tolerant investors open to higher yields but potential losses.
Risk Level
Lower risk due to accumulation feature.
Higher risk from income uncertainty.
Since we have covered preference shares features, it is important as an investor to know about its advantages and disadvantages of preference shares such as:
No Guaranteed Dividend Payout: Although dividends are declared, they are not guaranteed. If a company fails to make a profit, it can skip dividend payments (especially for non-cumulative shares).
Preference shares offer fixed dividends, priority in payouts but may have limited liquidity. Investors may consider preference shares if they fall under:
Preference shares are available on major exchanges (NSE/BSE) through a standard demat or trading account. Follow these steps:
Step 1: Through your brokerage account, access the stock market. Identify companies offering preference shares on NSE or BSE, these shares often appear in the equity list.
Step 2: Check if they are cumulative/non- cumulative, callable (redeemable by the company), or convertible.
Step 3: Place a buy order on your chosen preferred stock.
Step 4: Note that preference shares can have low trading volumes, making them harder to sell quickly compared to common equity.
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Preference shares offer a structured balance between stability and ownership by combining features of both debt and equity. They provide fixed dividend income, priority in payouts, and relatively lower risk compared to equity shares. For investors, the suitability of preference shares depends on their financial goals, income expectations, and risk appetite.
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Disclaimer: The information provided in this article is for general informational purposes only. For specific guidance or details, please consult with your Relationship Manager or a relevant expert.
