What are Preference Shares? Types, Features, and Benefits
Feels good to be able to skip a long queue, doesn’t it?
Well, Preference Shares or Preferred Shares are the stock market equivalent to the same. Having Preference Shares or Preferred Shares for a company implies having a special status of sorts, wherein you hold preferential rights over common shareholders when it comes to sharing profits.
What are Preference Shares?
Preference shares, or preferred stock, are a type of share that gives shareholders priority over common stockholders for dividend payments and asset distribution in the event of bankruptcy. These shareholders receive fixed dividends but typically do not have voting rights.
Experienced investors often favor preference shares because they offer higher dividends than common shares. Many investors exclusively hold preference shares due to their attractive returns.
Recently, companies have been issuing various types of preference shares, which combine features of both equity and debt, making them hybrid financial instruments. As global bear markets persist, preference shares have become increasingly popular for investors seeking stable long-term returns.
Features of Preference Shares
Dividend Preference: Preference shareholders receive dividends before common shareholders. The dividend rate is usually fixed, and it is paid out at regular intervals.
Also, explore the Highest Paying Dividend Stocks in India here.
Priority in Liquidation: During a company's liquidation, preference shareholders have a higher claim on the company’s assets compared to common shareholders.
Fixed Dividends: The dividends are generally fixed and can be a percentage of the nominal value or a specific amount per share.
Non-Voting: Preference shareholders do not have a say in corporate governance unless certain conditions are met, such as the non-payment of dividends.
Difference between Preference and Ordinary Shares
| Criteria | Preference Shares | Ordinary Shares |
| Dividend Payments | Dividends are typically fixed and are paid out before dividends on ordinary shares. | Dividends are not guaranteed and are paid after preference shareholders have received their fixed dividends. |
| Dividend Accumulation | Unpaid dividends accumulate and must be paid out before any dividends can be paid to ordinary shareholders. | If a company does not declare a dividend, ordinary shareholders do not receive any payment for that period. |
| Voting Rights | Do not have voting rights. | Have voting rights, allowing them to vote on corporate matters such as the election of the board of directors and major corporate policies. |
| Priority in Liquidation | Have a higher claim on the company’s assets than ordinary shareholders but are subordinate to debt holders. | Have the last claim on the company’s assets after all debts and preference shareholders have been paid. |
| Convertibility | Some preference shares are convertible into a specified number of ordinary shares at the discretion of the shareholder or the company. | Generally, ordinary shares are not convertible. |
Types of Preference Shares
Cumulative Preference Shares: If the company is not making profits or not paying dividends for a particular year, then whenever the company is making profits in the future, their payout will be adjusted at that point.
Non-cumulative Preference Shares: The dividend payout takes place from the profits made by the company in the current year. If there is a year in which the company doesn’t make any profit, then the shareholders cannot claim dividends in any future profit year.
Participating Preference Shares: Enjoy fixed dividends and also share a part of the surplus profit of the company along with equity shareholders.
Non-Participating Preference Shares: Do not yield the additional option of earning dividends from the surplus profits earned by the company. In this case, the shareholders receive only the fixed dividend.
Redeemable Preference Shares: Can only be redeemed at the time of winding up of the company.
Convertible Preference Shares: Enables the shareholders to convert their preference shares into equity shares at a fixed rate, after the expiry of a specified period as mentioned in the memorandum.
Non-convertible Preference Shares: Cannot be converted into equity shares. These shares will only get fixed dividend payout and also enjoy preferential dividend payout during the dissolution of a company.
How to Buy a Preference Share?
An active demat account on INDmoney or any desired brokerage fund allows you to buy a preference share of your choice. Do remember to research and evaluate different preference shares types and companies that offer them, including their financial performance, dividend history, and credit rating before you place an order. Get started here.
Advantages of Preference Shares
- Preference shares typically offer fixed dividend payments, providing a predictable income stream. This can be particularly attractive for income-focused investors.
- In the event of dividend payments or liquidation, preference shareholders have priority over ordinary shareholders.
- Many preference shares are cumulative, meaning any missed dividend payments accumulate and must be paid before any dividends can be paid to ordinary shareholders.
- Convertible preference shares can be converted into a specified number of ordinary shares.
- Preference shares tend to be less volatile than ordinary shares, making them a more stable investment, particularly in uncertain market conditions.
- Preference shareholders have a higher claim on the company’s assets compared to ordinary shareholders in the event of liquidation.
Risks Associated with Preference Shares
- Preference shares typically offer limited potential for capital gains compared to ordinary shares. They do not benefit as much from increases in the company’s stock price.
- Preference shares are sensitive to changes in interest rates. When interest rates rise, the fixed dividend payments from preference shares become less attractive, potentially leading to a decrease in their market value.
- Although preference shares generally offer fixed dividends, these dividends are not guaranteed. Companies may suspend dividend payments if they face financial difficulties, especially with non-cumulative preference shares.
- In the event of liquidation, preference shareholders have a higher claim on assets than ordinary shareholders but are subordinate to debt holders.
- Preference shareholders typically do not have voting rights, limiting their influence over corporate governance and major company decisions.
Overall, preference shares are often considered a hybrid between debt and equity. They provide regular income like bonds (through fixed dividends) and the potential for capital appreciation like stocks. However, the lack of voting rights and the fixed nature of dividends generally make them less volatile and less risky compared to common shares.
What is Preference Share in simple words?
Preference shares are a type of equity security that provides shareholders with preferential treatment regarding dividends and assets in the event of liquidation. Some key features of this type of shares include liquidation priority, no voting rights, and dividend preference over common shareholders.
What are examples of Preference Shares?
There are over 10 types of Preference shares, each with unique offerings to meet the needs of investors. Some examples of the same include Cumulative, non-cumulative, Redeemable, Convertible, Non-convertible, and more!
What are the 4 Preference Shares?
The four primary types of preference shares are callable shares, convertible shares, cumulative shares, and participatory shares. Each type possesses distinct characteristics that can provide advantages to either the shareholder or the issuer.
What is the difference between ordinary shares and preference shares?
Ordinary shares or common shares and preference shares differ in several aspects, including rights, risk levels, and dividends.