Understanding Preference Shares: Types and Benefits of Preferred Stock

What is Preference Shares?

Preference shares, also known as preferred stock, are a type of security that combines features of equity and debt. They grant holders fixed dividends and priority over common shareholders for dividend payments and asset claims during liquidation.

This hybrid nature makes preference shares an attractive option for companies seeking capital without issuing debt or diluting control, while offering investors more predictable income than common stock.

Key Characteristics

Preference shares have distinct features that differentiate them from common shares and bonds:

• Fixed dividends: Holders receive a predetermined dividend rate, often based on the face value, paid before common shareholders, providing steady income.
• Priority in payments: In liquidation, preference shareholders have a higher claim on assets than common shareholders but rank below debt holders.
• Limited voting rights: Usually, preference shareholders do not vote; however, some gain voting rights if dividends are in arrears.
• Types vary: Includes cumulative, non-cumulative, convertible, and participating preference shares, each with different dividend and conversion rights.
• Lower volatility: Preference shares tend to be less volatile than common stock, offering a more stable investment.

How It Works

When you invest in preference shares, you typically receive fixed dividends, often expressed as a percentage of the face value, before any dividends are paid to common shareholders. This priority reduces your income risk compared to common equity.

Many preference shares are issued by C-corporations to raise capital without increasing debt levels or diluting voting power. Some preference shares can convert into common shares, giving holders potential equity upside after meeting certain conditions.

Examples and Use Cases

Preference shares are common in various industries and investment strategies:

• Airlines: Companies like Delta issue preference shares to secure funding while maintaining operational control.
• Income-focused portfolios: Investors seeking steady dividend income may include preference shares alongside dividend stocks and ETFs, such as those featured in our best monthly dividend stocks and best dividend ETFs guides.
• Convertible preference shares: Offer a pathway to equity ownership if the company's stock price appreciates, blending income stability with growth potential.

Important Considerations

While preference shares provide stable income and priority claims, their fixed dividends may not keep pace with inflation or outperform common stock returns over time. They often come with limited or no voting rights, which affects your influence on company decisions.

Assess the rate of return in the context of your portfolio goals and consider how preference shares complement other investments, such as common stock or bonds. Understanding the specific terms, including cumulative rights or conversion features, is essential before investing.