What are Preference Shares and Its Type

Introduction

• When it comes to multiplying investments in a short span of time, most people tend to lean towards the stock market.
• Surprisingly, despite a considerable amount of risk, around 90% of investors incur losses in the stock market.
• Nevertheless, another type of share offers consistent returns at minimal risk and is known as a preference share. 
• This article will help you gain in-depth knowledge of these preference shares. Let's delve deeper into the types, features, and benefits of incorporating these shares into your financial portfolio.

 

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What are Preference Shares?

• Preference shares are also known as 'preferred shares' or 'preferred stock'.
• These shares give you specific preferences and rights over equity shareholders.
• They also pay fixed dividends, and their holders enjoy a higher claim on the company's assets and earnings than those holding equity shares. 
• In the event of the dissolution of a company, preference shareholders are entitled to receive their invested capital before other shareholders.

What are the Types of Preference Shares?

There are various types of preference shares. Some of the most common are:

1. Cumulative

The unpaid dividend is accumulated in cumulative preference shares, and the dividends are paid earlier than for equity shareholders.

2. Non-cumulative 

The unpaid dividend is not accounted for in non-cumulative preference shares. Thus, if the dividend cycle is skipped, then the shareholder won't be able to claim the unpaid amount in the next dividend cycle.

3. Convertible

These preference shares can be converted into a fixed number of common shares after a predetermined period or under specific conditions. This provides an opportunity for shareholders to benefit from potential capital appreciation.

What are the Features of Preference Shares?

Preference shares have certain distinguishing features. Some of the key features of preference shares are:

1. Fixed dividends

The shareholders receive fixed dividends, which are predetermined at the time of issuance. Hence, the preference shares can provide stable returns.

2. Priority of dividends

Preference shareholders have a higher claim on dividends compared to ordinary shareholders. This means they're entitled to receive dividends before common shareholders.

3. Priority of liquidation

Preference shareholders are repaid on priority during liquidation. Thus, they receive their invested capital before other shareholders.

Why Should I Invest in Preference Shares?

Investing in preference shares offers several advantages. Here are some reasons to consider investing in preference shares:

1. Capital preservation

Preference shareholders have a priority claim on assets and earnings in the event of liquidation. Hence, they enjoy a higher degree of capital preservation.

2. Diversification

Incorporating preference shares in one's investment portfolio can help diversify risk, as these boast superior risk-return characteristics to common shares.

3. Risk-return profile 

Preference shares usually exhibit different risk-return profiles, as compared to common shares. Fixed-income nature and priority in receiving dividends make them an attractive option for investing.

What are the Risks Associated with Preference Shares?

While preference shares offer unique features, it's important to consider the associated risks. Here are some risks of preference shares:

1. Call or redemption risk 

Issuers of preference shares may have the right to call back or redeem the shares at a predetermined price and date. This can expose investors to the risk of losing anticipated income or capital appreciation.

2. Market risk

Preference shares are subject to market fluctuations like any other investment and may experience price volatility.

3. Limited voting rights

Preference shareholders have limited or no voting rights. This means they have limited say in the company's decision-making process and future growth prospects.

Conclusion

• Preference shares offer investors an alternative investment avenue with a guaranteed return. Hence, they can be a valuable addition to a financial portfolio.
• They offer a great combination of stability and potential for income and capital appreciation. 
• However, before investing in preference shares, it's important to consider the associated risks. 
• Conducting thorough research or consulting a reliable financial investor can help you make informed investment decisions.

 

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