Author: Tom Drake
Source: MapleMoney
Preferred shares are a type of stock that will provide you with a share of ownership in a company. They are listed on a stock market, such as the Toronto Stock Exchange (TSX), the New York Stock Exchange (NYSE), or the Nasdaq, and can be purchased by individual investors through their online stock trading accounts. Preferred shares are not to be confused with common shares, which most investors are familiar with. While both grant the owner equity, there are a number of key differences.
How do preferred shares work?
Preferred shares are an ideal way for a company to raise capital, because they are often purchased in bulk by large institutions, rather than single investors. They are seen as both an equity and income security, because they appreciate in value similar to a common stock while paying a fixed dividend, which is more characteristic of a bond. This fixed dividend generally yields more than a common stock dividend.
Preferred shareholders do not have voting rights, but they do receive preferential treatment when it comes to a company's distributions. Dividends are paid out prior to common shares and If the company goes under, preferred shareholders have a higher claim on company assets than common shareholders.
The rights of preferred shareholders
Preferred shareholders do not have voting rights, but they have a priority claim on dividends and company assets vs. common shareholders. This makes preferred stock attractive to investors looking to manage volatility in their portfolio.
Preferred shares vs. common shares
There are a few key differences between preferred and common shares. Perhaps the biggest one is that common shareholders have voting rights, whereas preferred shareholders do not. This is important if you are wanting to have a say in the direction of the company you are investing in. In most cases, investors receive one vote for every share they own, and they elect company board members, and vote on major policy decisions.
While preferred shareholders cannot vote, they benefit from preferential treatment of company dividends, and a higher claim on assets if the company was to go under. Preferred dividends are fixed, and offer a higher yield than common share dividends. This provides investors with a predictable source of investment income.
Preferred shares vs. bonds
For some, preferred shares act as an alternative to bonds, as the fixed dividend offers a source of predictable income. When held in a non-registered investment account, they are considered more tax-efficient than bonds because dividend income is taxed at a lower rate than the interest income that is paid to bond owners. For this reason, it's usually better to keep bonds inside a registered account, such as a TFSA or RRSP.
Preferred shares are riskier than bonds, because companies pay out bond interest to investors before dividends on preferred and common shares. While bonds offer a lower return than preferred or common shares, they are considered the lowest risk investment of the three.
How to buy preferred shares
Before adding preferred shares to your portfolio, consider your overall investment objective as well as your recommended asset mix, just as you would before buying any other type of investment.
With any type of stock, you assume more risk if you can only buy shares in one or two companies. To properly diversify with preferred stocks, you'll need to invest in several companies across a variety of industries. Not everyone has enough money to do that.
Different classes of stock
In addition to preferred and common shares, companies issue different classes of stock. The primary reason they do this is to ensure that certain investors get preferred voting rights. A company may issue both Class A and Class B shares, each with different voting rights. Different share classes are listed separately on the stock exchange, using slightly different stock ticker symbols.
Preferred stock characteristics
- Can be purchased on the stock market
- No voting rights
- Lower risk than common stock, higher risk than bonds
- Considered both an income and equity investment
- Usually pays a fixed dividend
- Preferred dividend has a higher claim than common stock dividend
- Best purchased in a non-registered account for tax purposes
This article was written by Tom Drake fromMapleMoneyand was legally licensed through theIndustry Divepublisher network. Please direct all licensing questions tolegal@industrydive.com.
FAQs
Preference shares are company stock with dividends that are paid to shareholders before common stock dividends are paid out. A preferred dividend is one that is accrued and paid on a company's preferred shares. Their dividend payments take preference over common shares.
How do preferred shares work? ›
Preferred shares are issued to business owners and other investors as proof of the money they have paid into a company. They make up one part of a company's shareholder equity, the other two being common shares and retained earnings.
What are preferred shares for dummies? ›
Definition: Preferred stock is a special class of stock issued by a company that pays dividends. Preferred stock is more like a bond than true stock because the main appeal is dividend income. Most preferred stocks are limited in the total profit they can earn.
Who typically buys preferred shares? ›
Largely bought by income-oriented investors. Conservative individual investors seeking to take advantage of dividend tax credit. Companies also purchase as an income investment. Company votes to not pay one or more preferred dividends when due, the unpaid dividends accumulate in what is knows as arrears.
Why would someone choose preferred stock? ›
Preferred stock is attractive as it usually offers higher fixed-income payments than bonds with a lower investment per share. Preferred stockholders also have a priority claim over common stocks for dividend payments and liquidation proceeds. Its price is usually more stable than common stock.
What are the disadvantages of preferred shares? ›
Preferred stocks are usually less risky than common dividend stocks, and carry higher yields, but lack the opportunity for price appreciation as the issuing company grows. They also go without voting rights.
What does 7% preferred stock mean? ›
What Is an Example of a Preferred Stock? Consider a company is issuing a 7% preferred stock at a $1,000 par value. In turn, the investor would receive a $70 annual dividend, or $17.50 quarterly. Typically, this preferred stock will trade around its par value, behaving more similarly to a bond.
What is the most advantage of a preferred stock? ›
On the pro side, some of the best reasons to consider preferred stock include:
- Consistent dividend income, with fixed payout amounts and payment dates.
- First priority to receive dividend payouts ahead of common stock shareholders or creditors.
- Potential for larger dividends, compared to common stock shares.
7 Best Preferred Stock ETFs to Buy Now
| Preferred Stock ETF | Dividend Yield* | Expense Ratio |
|---|
| Global X U.S. Preferred ETF (PFFD) | 6.3% | 0.23% |
| iShares Preferred and Income Securities ETF (PFF) | 6.5% | 0.46% |
| First Trust Preferred Securities and Income ETF (FPE) | 5.9% | 0.84% |
| Invesco Preferred ETF (PGF) | 5.5% | 0.56% |
3 more rowsMar 27, 2024
Most shareholders are attracted to preferred stocks because they offer more consistent dividends than common shares and higher payments than bonds. However, these dividend payments can be deferred by the company if it falls into a period of tight cash flow or other financial hardship.
Preferred shares can offer an avenue for income investors wanting more yield than either corporate or government bonds. At the same time, these shares allow people to buy into an investment that offers a bit more safety than common stock. Yields are subject to change with economic conditions.
How risky are preference shares? ›
Risks associated with preference shares
Lack of voting rights: Preference shareholders do not have a say in the company's decisions, which can be a disadvantage if the company's management makes unfavourable choices.
Why would a company issue preferred shares instead of common shares? ›
Issuing preferred stock provides a company with a means of obtaining capital without increasing the company's overall level of outstanding debt. This helps keep the company's debt-to-equity (D/E) ratio, an important leverage measure for investors and analysts, at a lower, more attractive level.
What is another name for preferred stock? ›
Preferred stock (also called preferred shares, preference shares, or simply preferreds) is a component of share capital that may have any combination of features not possessed by common stock, including properties of both an equity and a debt instrument, and is generally considered a hybrid instrument.
What is one drawback to owning preferred stock in a corporation stockholder? ›
The main disadvantage of owning preference shares is that the investors in these vehicles don't enjoy the same voting rights as common shareholders. 1 This means that the company is not beholden to preferred shareholders the way it is to traditional equity shareholders.
How to value preferred stock? ›
The formula for calculating the cost of preferred stock is the annual preferred dividend payment divided by the current share price of the stock.
How do you get paid with preferred stock? ›
Preferred stocks promise a steady stream of income through dividend payments. A preferred stock's dividend payments are usually higher than bond payments and they're set at a fixed rate, usually somewhere between 5–7%. They're also paid out before common stock dividends, but after bondholders receive their payments.
Why do preferred shares lose value? ›
Preferred stock is sensitive to fluctuations in interest rates. Like bonds, when interest rates rise, the price of preferred shares typically falls as their yields increase. But when interest rates fall, preferred shares become worth more.
Do preferred shares always pay dividends? ›
Unlike a bond, preferred stock dividends are not guaranteed, so the issuer can skip out on paying dividends to preferred shareholders if the company is not profitable.
What happens when a preferred stock gets called? ›
An investor owning a callable preferred stock has the benefits of a steady return. However, if the preferred issue is called by the issuer, the investor will most likely be faced with the prospect of reinvesting the proceeds at a lower dividend or interest rate.
