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What Is Preference Shares

24 Aug 2023

Introduction

The Indian stock market is a lucrative place to grow your money. You can invest a portion of your capital and generate better returns over time, especially when inflation rates are high. 

However, many novice investors buy shares without knowing their types and conducting appropriate research. As an investor, having a sound knowledge of the types of shares available within the stock market can help you make a better decision. These shares can have different features, return potential and risk profiles. 

The two main types of shares are equity shares and preference shares. This article will discuss preference shares, their features and their types.

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What are preference shares?

Preference shares are also known as preferred stock. These shares enjoy priority over other shares in dividend payouts during the company’s lifetime. It implies that preference shareholders will first receive the dividends if the company makes profits. Only after this, the company can issue dividends to other shareholders.  

The capital raised through preference shares is referred to as preference share capital. Preference shareholders also enjoy the right to capital repayment if the company is liquidated. However, preference shareholders are not entitled to vote except in extraordinary circumstances. 

Features of preference shares  

Preference shares have the following characteristics:

  • Dividend payout: Regarding dividend payouts, preference shareholders enjoy the right to receive them on a priority basis over other shareholders. 
  • Fixed dividends: Preference shareholders receive fixed dividends.
  • Dividend preference: Holders of preference shares receive dividends even when other shareholders don’t or receive them later.
  • Preference in assets: Preference shareholders enjoy priority in claiming company assets if it goes into liquidation.
  • Voting rights: Holders of preference shares don’t enjoy voting rights and have no say in the company’s decision-making process. However, they are entitled to vote in extraordinary circumstances.
  • Convertibility: Preference shares can be converted into common stocks. If you want to change your holding position, you can convert it into a pre-decided number of non-preference stocks.
  • Callabilty: Preference shares can be called by the issuing company for repurchasing at a fixed price in the future. 

Types of preference shares 

Here are the types of preference shares prevalent in India:

  • Cumulative: Cumulative preference shares offer the right to receive dividend payouts in arrears. The dividends are regarded as arrears in the years when the company is underperforming. In such a scenario, the company can issue cumulative dividends next year or whenever it starts making profits.
  • Non-cumulative: Non-cumulative preference shares do not give investors the right to receive dividends in arrears. The dividends are paid only out of the profits generated by the company in the current year. In other words, shareholders do not receive dividends when a company is not making profits. Furthermore, they cannot claim any dividend payout in the future.
  • Redeemable: Redeemable preference shares allow the issuing company to buy back the shares at a fixed rate and date. These shares act as a cushion against inflation for the company. 
  • Irredeemable: Irredeemable preference shares cannot be redeemed or repurchased by the issuing company during its lifetime. The company can redeem them only in case of liquidation or winding up of the business.
  • Convertible: Convertible preference shares can be converted into equity shares at a fixed rate after a specified period stated in the memorandum.
  • Non-convertible: Non-convertible preference shares cannot be converted into equity shares.
  • Participating: Participating preference shares provide a share in the company’s surplus profit, which is over and above the specified rate of preferred dividend. So, holders of these shares receive fixed dividends and also enjoy a share in the company’s surplus profit after other shareholders have received dividends.
  • Non-participating:  Holders of these shares do not enjoy the right to claim any share from the company’s surplus profit. They are entitled to receive fixed dividends only.

Conclusion 

Preference shares represent the characteristics of debt and equity investments and are therefore regarded as a hybrid security option. They allow you to earn fixed-income dividends with a lower degree of risk as compared to ordinary shares. You can consider investing in preference shares if you have a low-risk appetite and desire assured dividends. You can also convert these shares into equity and take advantage when the company performs exceptionally well. 

 

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