What Are Preferred Stocks?

Although equity shares are the most popular, they are far from the only category of shares that a company can issue. In fact, there is another type of share known as preferred shares that many companies issue. In this article, we are going to demystify the concept of preferred stock, explore its various features and types, and look into the advantages that you get by investing in them. 

What are Preferred Shares?

Preferred stocks, also known as preference shares or preferred shares, are a unique class of shares that combine the features of regular shares and bonds. Similar to equity shares, preferred shares also represent ownership in the company. However, they offer a fixed dividend payment akin to the interest payments on bonds. 

Features of Preferred Stocks

Preferred stocks possess several distinct characteristics, making them an attractive option for certain investors. Here are some of the key features of preferred shares. 

1. Fixed Dividend 

Preference shareholders enjoy a fixed dividend, which is often higher than what equity shareholders receive. The rate of dividend is set as a percentage of the par value of the share. 

2. Priority Claim

Holders of preferred stocks enjoy priority claims over equity shareholders on the earnings and assets of the company. 

3. Limited Growth Potential 

Since preferred shares have a fixed par value, their prices typically do not appreciate significantly over time like regular equity stocks.

4. Redeemability 

Preferred stocks also often come with a callable feature. This feature enables the issuing company to repurchase or redeem the shares at a predetermined price after a specific date.

5. No Voting Rights 

Although preferred shareholders are considered owners of the company, they typically do not get any voting rights and are not eligible to participate in any of the general meetings that the company conducts. 

Types of Preferred Stocks 

Even among preferred shares, there are multiple classes, each with unique characteristics. As an investor, understanding the various types of preferred stock is crucial for making effective investment decisions. 

1. Cumulative Preferred Stock 

Cumulative preferred shares accumulate dividends missed due to low or no earnings. These unpaid dividends must be paid before issuing any dividends to equity stockholders. 

2. Non-Cumulative Preferred Stock 

Non-cumulative preferred stock does not accumulate any missed dividends. If the company misses out on paying dividends for a particular year, citing low or no earnings, preference stockholders will lose their claim to that year’s dividends.   

3. Convertible Preferred Stock 

As the name implies, convertible preferred shares can be converted to equity shares. The date of conversion and the conversion rate will be specified beforehand, often at the time of issue of the shares.  

4. Redeemable Preferred Stock 

Redeemable preference shares can be redeemed or bought back by the company after the expiry of a certain period. 

5. Irredeemable Preferred Stock 

Irredeemable preferred shares are perpetual and cannot be redeemed, bought back, or converted to equity shares. However, as per the provisions of the Companies Act of 2013, no company in India is allowed to issue irredeemable preferred stock. 

Advantages of Preferred Stocks

Preferred stocks offer several advantages that make them attractive to certain investors. Here is a quick overview of some of the key benefits. 

• The fixed dividend payments provide investors with a reliable income stream, which can be especially valuable for retirees or income-focused individuals.
• In the event of company liquidation or earnings distribution, preferred stockholders have a higher claim than common stockholders. This makes the shares low-risk and suitable for conservative investors.
• Issuing preferred stock can be advantageous for the company since it does not dilute the voting rights of existing common shareholders. 
• Another advantage for the issuing company is that the payment of dividends to preferred stockholders is not a mandatory obligation like bond interest payments. In the case of low or no earnings, the company can simply defer the payments.  

Conclusion 

By blending the characteristics of traditional stocks and bonds, preferred shares occupy a unique position that makes them very attractive to certain investors. By investing in them, individuals get a way to potentially earn higher returns than bonds while taking on less risk than common stocks. 

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