What is preference shares ?

Preference shares, also known as preferred stock, are a type of equity security that provides certain privileges to shareholders, primarily related to dividend payments and asset distribution. These shares are an attractive investment option for individuals seeking stable returns with less risk compared to common equity shares.

Key Features of Preference Shares

1. Priority in Dividends:
   • Preference shareholders receive dividends before common shareholders.
   • Dividends are usually fixed and can be cumulative or non-cumulative.
2. Priority in Asset Distribution:
   • In the event of liquidation, preference shareholders have a higher claim on assets than common shareholders.
3. Fixed Dividend:
   • Dividends on preference shares are generally fixed as a percentage of the par value.
   • These dividends are often more stable and predictable compared to common shares.
4. Non-Voting Rights:
   • Typically, preference shareholders do not have voting rights in company decisions, unlike common shareholders.
5. Convertibility:
   • Some preference shares can be converted into common shares at a predetermined rate.
6. Redeemability:
   • Redeemable preference shares can be bought back by the company after a certain period or on a specified date.

Types of Preference Shares

1. Cumulative Preference Shares:
   • If dividends are not paid in any year, they accumulate and must be paid out before any dividends are given to common shareholders in the future.
2. Non-Cumulative Preference Shares:
   • Dividends do not accumulate if they are not paid in any year. Shareholders lose the right to unpaid dividends for that year.
3. Convertible Preference Shares:
   • These shares can be converted into a specified number of common shares after a certain period.
4. Non-Convertible Preference Shares:
   • These shares cannot be converted into common shares.
5. Redeemable Preference Shares:
   • The company can buy back these shares after a specified period.
6. Irredeemable Preference Shares:
   • These shares cannot be redeemed during the lifetime of the company.

Advantages of Preference Shares

1. Stable Income:
   • Preference shares provide a fixed income through regular dividends, making them attractive for risk-averse investors.
2. Higher Claim on Assets:
   • Preference shareholders have a higher claim on company assets in the event of liquidation compared to common shareholders.
3. Dividend Priority:
   • Preference shareholders receive dividends before common shareholders.
4. Lower Risk:
   • Preference shares are generally considered less risky than common shares due to their fixed dividend and priority in asset distribution.

Disadvantages of Preference Shares

1. Limited Upside:
   • Unlike common shares, preference shares do not benefit from significant capital appreciation as they offer fixed dividends.
2. No Voting Rights:
   • Preference shareholders typically do not have voting rights in the company’s decision-making processes.
3. Interest Rate Sensitivity:
   • The value of preference shares can be affected by changes in interest rates, similar to bonds.

Also Read: What do you mean by redemption of preference shares ?

Conclusion

Preference shares offer a balance between the stability of bonds and the potential growth of common shares. They provide a fixed income with lower risk, making them a suitable investment for individuals seeking regular dividends and higher claims on assets. However, they come with limitations such as limited upside potential and no voting rights. Understanding the features, advantages, and disadvantages of preference shares can help investors make informed decisions and diversify their investment portfolios effectively.