Preference shares are a form of equity investment that entitles their holder to a fixed dividend before the distribution of profits to regular shareholders. These shares incorporate features of both equity and debt and are therefore highly valued by investors because they give stable returns.
Preference shares allow companies to raise capital while establishing firm control over decision-making. Investors and businesses become better informed in their financial decisions by being familiar with the types, attributes, and benefits of preference shares.
Continue reading this blog to learn about what are preference shares, their features, benefits and more.
Snapshot Definition: Preference Shares
| Term | Preference Shares |
| Also known as | Preferred Stock |
| Key Rights | Priority dividend + priority claim on assets |
| Voting Rights | Generally limited or none |
| Best For | Investors seeking steady income + companies that want non-dilutive capital |
What are Preference Shares?
Preference shares belong to a particular class of shares where preference shareholders are provided dividends as announced by the company before the equity shareholders. Preference shares thus enable shareholders to claim dividends during the lifetime of a company as well as the option of repayment of capital.
If a company goes bankrupt, shareholders with preference shares are paid from the company’s assets before common shareholders. Despite not being provided with any voting rights, preference shareholders get additional financial compensation and capital gains.
Investors wanting exposure to the stock market can invest in preference shares to get a steady income for a lengthy period. The dividends received from preferred shares are generally higher compared to those from ordinary shares. However, these stocks usually have lower appreciation rates than common shares.
What are the characteristics of Preference Shares?
Investors can earn more during economic downturns with preference shares because of its features. Let’s explore the features of preference shares in detail below:
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Stable Returns
Corporations that offer preference shares must pay out dividends (at fixed or floating rates) to preference shareholders at predetermined intervals. Thus, preference shares operate similarly to debt securities as they offer mandatory fixed payments. Because of this nature of fixed income, investors aiming to earn steady monthly income opt for preference shares.
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Assured Dividend Payouts
Preferred shareholders are assured dividend payouts at the known rate by the issuing company before regular equity shareholders. If the issuer distributes dividend payouts, preference shareholders have priority in receiving them before common shareholders.
Furthermore, for certain types of preference shares (cumulative), the dividends to be paid out accumulate if the issuing company fails to make the required dividend payments. If a company fails to pay out dividends in any year, the money left to pay out accumulates. The pending dividend must be paid out later to preferred shareholders before they are divided among common shareholders.
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Absence of Voting Rights
Preference shares do not let shareholders provide any voting rights. Thus, preferred shareholders have no individual opinion in the overall process of making decisions. Because there are no voting rights, many companies provide investors with preference shares to prevent shareholder’s influence on the operations of the company.
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Other Features
Redeemable preference shares are another category of preference shares that investors can choose to purchase.
As the name suggests, companies are eligible to purchase these shares after a specific period or in a particular time frame. Furthermore, a company can also offer callable shares, a unique type of preference shares where the company can buy back the shares after a particular time frame.
What are the different types of Preference Shares?
The different types of preference shares a company can issue are the following:
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Adjustable Preference Shares
Adjustable-rate preferred stocks (APRS) are a special type of preference stock where the issuer chooses a benchmark to determine the dividend payouts. These preference shares basically follow a benchmark like T-bill rates and the dividends are periodically reset based on changes in the benchmark. The stability of market values makes these stocks attractive for investors with moderate risk appetite.
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Redeemable Preference Shares
Redeemable shares are a kind of stock which the issuing company can buy back after a particular time frame and on any mentioned date. These preference shares usually have a predetermined price and specific date. With redeemable preference shares, investors get an idea about the dividend amount as well as proceeds from the buyback.
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Irredeemable Preference Shares
Irredeemable preference shares are also called perpetual preference shares. These shares are exactly the reverse of their redeemable counterpart. This particular type of share does not have any date of redemption, and the issuer is unable to repurchase it. Thus, the time a company can repurchase these shares is when it stops operating.
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Participating Preference Shares
Investors willing to earn additional income opt for participating preference shares. This type of share provides shareholders with the right to earn extra income alongside the fixed dividend amount. These extra dividends are usually distributed by a company when the earned profits exceed the predefined amount.
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Non-participating Preference Shares
With non-participating preference shares, shareholders don’t receive any extra dividends apart from the fixed dividend amount. However, shareholders holding these shares obtain their predetermined amount irrespective of the financial performance of the company. Thus, shareholders here receive a stable income but not higher earnings in comparison with participating preference shares.
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Convertible Preference Shares
These preference shares enable shareholders to convert their holdings into common equity. With this type of share, investors can get the dual advantages of fixed income and capital appreciation. These shares offer investors a perfect blend of income and growth, which investors can further convert according to their convenience.
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Non-convertible Preference Shares
As the name suggests, non-convertible shares don’t allow shareholders to convert their shares into common equity. With this kind of preference share, investors receive fixed income from dividends, and it is the same as other kinds of preference shares.
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Cumulative Preference Shares
Cumulative shares are those that allow respective shareholders to obtain dividends not paid by the company in past years. If any particular company runs into losses and fails to pay out dividends to respective shareholders, the dividend amount remains pending.
This unpaid accumulated dividend must be paid out by the company to shareholders of cumulative preferred shareholders before payouts can be made to other equity shareholders.
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Non-cumulative Preference Shares
With non-cumulative preference shares, shareholders are entitled to receive dividends before they are paid out to common shareholders if and when they are issued. However, the company has to pay dividends only when it makes net profits.
However, if the company incurs losses and continues to miss dividend payments, non-cumulative preference shareholders cannot claim the missed or pending dividends later. This type of share is associated with more risk compared with cumulative preference shares, providing less guarantee of getting unpaid dividends.
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Callable Preference Shares
These are shares that grant the issuing company the right to repurchase them at a predetermined price and date. In the respective prospectus of the issuing company, the share’s call price and date must be mentioned. This kind of preference share typically offers higher income to investors to compensate for the higher risk of calls before reaching the maturity period, thereby causing the dividend payout to be limited for investors.
Benefits of Preference Shares
There are several benefits of preference shares for both the companies and investors. Let’s look into the key advantages in detail below:
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Stable Source of Income
By opting for preference shares, shareholders are eligible to receive a fixed dividend amount, which thereby provides them a stable source of income. This share is thus particularly beneficial for investors in search of a steady rate of returns.
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No Dilution of Ownership
Preference shares prevent dilution of ownership of existing shareholders, unlike common shares. This thereby indicates that existing shareholders are capable of maintaining their ownership percentage in the company.
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Priority of Dividends
This is another key advantage of preference shares. The preferred shareholders receive priority when it comes to dividend payouts. In simple words, preference shareholders are paid dividends the very first before it is distributed further among common shareholders.
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Conversion Facilities
Convertible shares provide shareholders the option of converting their preference shares to regular equity. With this facility, shareholders can obtain regular income from the dividends of preference shares and earn higher capital gains after availing of the conversion facility.
Drawbacks of Preference Shares
Here are some notable limitations of investing in preference shares:
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Risk of Unfavourable Calls
A company may call in for callable preference shares from investors after a specific time frame at a price. Here, the company can decide to repurchase previously issued shares when there is a decline in market interest rates. This, thereby, causes investors to sell off at lower than market rates.
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Risk of Offsets by Inflation
Preference shares have inflation risk, as shareholders obtain a fixed income even during high inflation in the economy. This, thereby, reduces the actual value of dividend income and lowers shareholders’ overall buying power.
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Lack of Voting Rights
Preferred shareholders have limited voting rights. This is another disadvantage of preference shares. Although the shareholders receive dividends on a fixed basis, they are not eligible to vote and cannot influence the decision-making of a company through general meetings.
Investor Checklist: What to Evaluate Before Investing in Preference Shares
Before buying preference shares, investors should evaluate the following key factors:
- Dividend rate and payout frequency
- Whether the share is cumulative or non-cumulative
- Convertibility feature (convertible or non-convertible)
- Redemption terms (redeemable vs irredeemable)
- Call provisions and call price
- Financial health of the issuing company
- Liquidity on the exchange (how actively the share trades)
This checklist helps investors make a more informed decision.
Pros and Cons of Preference Shares
| Advantages | Limitations |
| Fixed dividend payments | Lower growth potential |
| Priority over equity shareholders in dividend & liquidation | Limited or no voting rights |
| Lower risk compared to common equity | Inflation may reduce real returns |
| Conversion options available (for convertible shares) | Callable shares may be redeemed early |
Why Should You Invest in Preference Shares?
After learning the preference shares meaning, every investor will be keen to know why they should invest in these shares. Here are the reasons:
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Yield Higher and Regular Returns
An important benefit of preference shares is that these shares yield higher returns in the form of dividends. However, it is important to note that the consistency of these dividends is dependent on the kind of preference shares.
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Low Risks
Preference shares carry low risks in comparison with common shares. If the company providing dividends gets closed, the preferred shareholders are the ones to receive compensation first. People investing in preference shares undertake low risks of losses of the principal amount.
Final Words
Overall, preference shares maintain a balance between risk and rewards, thus offering an attraction for both companies and investors. Preference shares provide security as a source of finance through guaranteed dividends that come ahead of common shareholders, giving certain financial security. This profit model may help companies raise funds without losing control while providing the investor with guaranteed returns.
However, the fixed rate of return and the absence of voting rights may not be suitable for investors who seek growth or control in decision-making. Again, preference share investments contribute valuably to a company’s growth, providing reliable income returns for the investor.
