Preference Shares

Preference shares (preferred stock) are a class of equity that combines features of common stock and fixed-income securities. Holders typically receive dividends before common shareholders and have priority in asset distribution if a company is liquidated. In exchange, preferred shareholders usually have limited or no voting rights and less upside participation in company growth.

Key features

• Priority dividends: Dividends are paid to preferred shareholders before common shareholders.
• Fixed or stated dividend rate: Many preferred issues pay a fixed dividend, making them attractive to income-focused investors.
• Limited voting rights: Preferred shares generally carry fewer (or no) voting rights compared with common stock.
• Bankruptcy priority: Preferred shareholders rank above common shareholders for claims on assets, but below creditors and bondholders.
• Hybrid characteristics: Preferred shares behave like equities (ownership) while offering some predictable income like bonds.

Main types of preference shares

Cumulative preferred

Holders are entitled to receive all unpaid dividends (dividends in arrears) before any dividends are paid to common shareholders. Missed dividends accumulate and must be paid when the company resumes payments.

Dividend examples:
* Quarterly dividend = (Dividend rate × Par value) ÷ 4
* Cumulative dividends owed = Quarterly dividend × Number of missed payments

Non-cumulative preferred

If the board omits or suspends a dividend, non-cumulative preferred shareholders have no right to claim those missed dividends in the future. They only receive dividends declared after they hold the shares.

Participating preferred

Holders receive their stated preferred dividend and may also share in additional dividends paid to common shareholders if certain conditions are met (for example, when common dividends exceed a threshold). In liquidation, they may receive their purchase price plus a pro rata share of remaining proceeds.

Convertible preferred

Convertible preferred can be exchanged for a predetermined number of common shares, usually at the shareholder’s option and after a specified date. Conversion value depends on the performance and price of the common stock, offering potential upside.

How preferred shares compare to other securities

• Versus common stock: Preferred shares have dividend priority and typically less upside and voting power.
• Versus bonds: Preferred shares are junior to debt in bankruptcy and do not have a fixed repayment date, so they are generally riskier than bonds but can offer higher yields.

Advantages and disadvantages

Advantages
* More predictable income through stated dividends.
* Higher priority than common equity for dividends and liquidation proceeds.
* Potential additional benefits with participating or convertible features.

Disadvantages
* Limited capital appreciation compared with common stock.
* Lower priority than creditors and bondholders in bankruptcy.
* Non-cumulative issues may forfeit unpaid dividends permanently.
* Limited or no voting rights.

When to consider preferred shares

Preferred shares suit investors seeking higher, more stable income than common dividends with greater priority than common stock, but who are willing to trade off voting rights and some upside. They can fit income-focused or risk-averse equity allocations, but suitability depends on individual goals and the specific terms of the issue.

Bottom line

Preference shares offer a middle ground between bonds and common equity: priority income and liquidation claims, often with fixed dividends, but limited voting rights and less participation in company growth. Different types (cumulative, non-cumulative, participating, convertible) carry distinct rights and risks—review the specific terms before investing.