What is preference share can be answered by saying it is a special category of dividends that are paid before the common stock dividends issue. Moreover, the shareholders of preference shares hold preferential rights while sharing profits over the common stockholders. Suppose, if a company faces bankruptcy, then the shareholders of the preference shares have the first right over the company assets and are issued the dividends first before the common stockholders. However, as opposed to common stock investors, preference shareholders do not have voting rights and are paid a fixed dividend.
The older players in the stock market prefer it who knows what is preference share. The dividend earns from the preference shares is advantageous in the long run. Moreover, the preference returns are comparatively higher than the other ordinary shares. They include the essence of both debt and equity shares for which it refers to hybrid financing instruments.
The question of what is preference share features completes when they act as earners during phases like low economic growth. Furthermore, the reason investors opt for these financial instruments are as follows:
- Preference shares are a long term source of finance that is non-tax deductible with a fixed rate of dividend despite any amount of profits.
- Due to the first rights over the dividend of the company, preference shares have more significance than the other standard shareholders.
- When we understand what is preference share, there are no votings rights in the business proceedings to the shareholders which becomes the major reason why the company offers these shares.
- One feature that does not spotlight is to know that preference share includes the payment of dividend on specific dates rather entirely a monthly income.
- However, irredeemable preference shares need a look upon, since the shareholder has a certain say on his maturity date.
- The preferences share seem identical to PAT since the tax decides on the dividend payable on the prearranged fund of dividend.
- Also, preference shares are costlier to issue as compared to debt.
How to Calculate Preferred Stock
The formula below along with an example explains how to calculate preferred stock. The calculation for the cost of preferred stock, however, is similar to the perpetuity formula.
How to calculate preferred stock formula:
Rp = D / Po Where D = Dividend , Po = Current Price
For example, Question: How to calculate preferred stock when the annual dividend paid for it is $4 with a current price of $25. Answer: Rp= 4 / 25 = 16%
The company’s management chooses among the best alternatives among the financing options by analyzing the costs. As a result, when preferred stocks (what is preference share) are paid dividends each year then it is included in the price of raising capital.
Since the cost of common stock varies with the demand and supply forces of the market, therefore, preferred stock is considered more valuable which ensures greater security if the company defaults or folds.
To determine what is preference share types, the types of shares are differentiated based on the clause at the time of issue in the agreement which is major as follows:
Types of shares in this category: 1. Non-cumulative preference shares 2. Cumulative preference shares 3. Non-participating preference shares 4. Participating preference shares 5. Non-convertible preference shares 6. Convertible preference shares 7. Irredeemable preference shares 8. Redeemable preference shares
Non-cumulative preference shares
Firstly, non-cumulative dividends if not paid do not accumulate when they are due. The dividend for these types of shares is paid only via current year profits i.e if the company does not earn sufficient profits, the shareholders get partial or no dividends. Moreover, the holders can neither claim for arrears nor the unpaid dividend is carried forward to successive years.
Cumulative preference shares
Secondly, the right on dividend even when the company makes no profit is termed as cumulative preference shares(what is preference share). This explains that whenever the company makes inadequate profits, the dividends may not be paid in the current year but are treated as arrears. Therefore, it accumulates and payable in successive years’ profits. Moreover, other types of shares can be paid only after the fulfilment of arrears. The company pays the shareholders before the dividends of equity.
Non-participating preference shares
In these types of shares, the shareholders receive the stated dividends only. The investors surrender to claim for extra earnings for the right to receive the dividend stated. The non-participating preference shares (what is preference share) neither have the right on surplus profits left after equity shares payment(during lifetime) nor in surplus assets(during winding up).
Participating preference shares
Fourthly, the shares which receive a stipulated rate of dividends and also get a share in additional earnings along with equity investors are termed as participating preference shares (what is preference share). The shareholders have right over the surpluses left during the lifetime of the company after paying all types and in surplus assets during winding up along with equity shareholders in an agreed ratio.
Non-Redeemable preference shares
Next explains the shares that are permanent with continuous shareholding until the company reaches the level of liquidation. As a result, the investors redeem the preference shares after the expiry of the mentioned period. Also, the clause of incorporation for redemption does not exist and therefore cannot be bought back by the wish of issuing company.
Redeemable preference shares
Also termed as option embedded(what is preference share), the shares that can be redeemed after the discretion of the company or after the mentioned period is known as redeemable preference shares. However, this kind is advantageous for the company which acts as a hedge against inflation. This happens when the rate declines, the company redeem the shares or refinance them at a lower rate. Here, in the clause, the redemption price range is predetermined and the company can even buy back the shares before the specified period.
Convertible preference shares
Convertible preference shares (what is preference share) are those that can be converted into equity shares on the expiry of the specified period at the stated rate. The holders have the right to convert them into equity shares. This kind of shares may also include participating or cumulative rights. As a result, these types of shares becomes ideal from the vision of investors.
Non-convertible preference shares
These types of shares are opposite to the convertible shares discussed above. Non-convertible preference shareholders do not have the right of the conversion into equity shares. However, there is an additional point that non-convertible preference shares can also be redeemed.
Preferred stock examples
- In various countries, the issuance of preferred stock is encouraged in banks for the source of Tier 1 capital. However, preferred stocks(what is preference share) become common in pre-public or private companies where the differentiation in economic interest and control of the company is useful.
- A company going for venture capital or other types of funding may wish to go for various rounds of financing to issue several classes of preference shares.
- In the United States, there are two preferred stock examples; one convertible and the other straight. Straight preferred stock examples issue stipulated dividend rate and in perpetuity whereas a convertible preferred stock example converts into the common stock under certain conditions.
Preferred stock vs Common stock
In the main topic of (what is preference share) preferred stock vs common stock, the major point of differentiation is that preference shareholders have no voting rights. This explains that the preferred stock investors do not have a say in future of the company whereas the common stockholders have.
The investors for preferred stock (what is preference share) are paid a fixed dividend in perpetuity. However, this scenario is different in common stock where the dividends are variable, declares BOD and never guaranteed.
In preferred stock vs common stock, the par value of the preferred stocks also affects by interest rates( rise in interest rates or price level accounting decreases the value of the stock). Whereas, the value of common shares regulates by the supply and demand of the market participants.
Payment during defaults
Preferred stock (what is preference share) arrears of dividend are paid before the common shareholders. During liquidation, the preferred stock investors have a higher claim for company earnings and assets.
The character of callability in preferred stock (what is preferred share) allows the investor the redeem shares after a specified period. The different types of preference shares allow them to call back at a redemption rate. Where the prices may bid up accordingly not offered by common stock.
|BASICS||PREFERRED STOCK||COMMON STOCK|
|Value till maturity||Remains full||Varies|
|Payment order if company defaults||Second||Third|
|Categorization||Further subcategories||No further division|
|Risk and return||Less risky and lower returns||Greater risk but higher returns|
Equity shares are one of the common terms in the stock market popularly as ordinary shares. It acts as the main long term source of finance issued to the public. This further explains that investing/buying equity shares fractionally makes the investor, the owner of the company. Owning equity shares gives voting rights in general meetings or in the working of the company. Also, the equity shareholders receive the dividend, the rate or the payout ratio of which depends on the firm.
- It is a long term source of finance that is permanent.
- Secondly, it counts as permanent assets of the company and gets a return while winding up.
- Dividend payout depends on the available funds with the company. This explains that if the company does not make profits then shareholders might not be paid dividends.
- The transfer of ownership points tells that it is easy to pass on to another person.
- Although equity shares are riskier, it in turn gives a higher return to investors.