Preference shares, also known as preferred stock or preferred shares, are a type of equity asset issued by a firm that has characteristics of both equity and debt securities. They denote ownership in a corporation and allow shareholders to receive dividends before common shareholders. Here’s an outline of preference shares, including its qualities, benefits, and considerations:
Features of Preference Shares
1) Dividends:
- Preference stockholders are paid predetermined dividends at regular intervals. These dividends are usually paid out before any dividends are delivered to common shareholders.
2) Priority for Liquidation:
- In the case of liquidation or bankruptcy, preference shareholders have a greater claim to assets than common shareholders. They have priority over common shareholders when it comes to receiving their investment capital.
3) Non-voting Rights:
- Unlike regular shareholders, preference shareholders often do not have voting rights in corporate decisions. However, under certain situations, some preferred shares may have limited voting rights.
4) Types of Preferred Shares:
- Preference shares may be cumulative or non-cumulative. Cumulative preference shares accrue unpaid dividends, which must be paid before dividends are delivered to common shareholders in subsequent years. Non-cumulative preference shares do not accrue unpaid dividends.
Advantages of Preference Shares
1) Steady Income:
- The constant dividend feature offers investors a consistent income stream, making preference shares appealing to income-oriented investors.
2) Priority in Dividends:
- Preference shareholders receive dividends before common stockholders, providing them with greater income security.
3) Risk Mitigation:
- Preference shares include characteristics of both equity and debt, offering a balance of risk and reward for investors seeking income with a lesser risk than common shares.
Considerations
1) Limited Capital Appreciation:
- Preference shares normally do not rise in value as much as regular shares, reducing owners’ potential capital gains.
2) Interest Rate Sensitivity:
- The market value of preference shares might fluctuate in response to interest rate fluctuations, reducing their attractiveness in comparison to alternative investments.
Conclusion:
Preference shares are a unique investment option that appeals to investors looking for consistent income and capital preservation. Their set dividend characteristic and priority in liquidation provide some protection, but with limited growth potential when compared to common shares. Understanding the characteristics and considerations of preference shares is critical for investors seeking to diversify their portfolios and meet certain financial goals.
