Stock market 101: What are preference shares?

Julie Brownlee, Fsp Invest, 17 Nov. 2014

Tags: preference shares, what are preference shares, preference share, share, risks of preference shares, types of preference share,

When you invest in shares, the vast majority of investors opt for ordinary shares. But did you know there are other types of shares that some companies issue?

These are preference shares.

So what are preference shares? Are there different types of preference share? And what are the risks involved with investing in preference shares?

Let’s take a closer look…

The ins and outs of preference shares

When you buy ordinary shares in a company, you’re entitled to your share of the profits that remain once the company pays all of its other expenses.

Preference shares work in a slightly different way.

Preference shares usually pay a fixed dividend. The company pays this dividend from its post -tax profits. A company pays its preference shareholders their dividends before its ordinary shareholders.

If a company decides that it’s not paying its preference shareholders a dividend, then it can’t pay a dividend to its ordinary shareholders.

And it’s not just dividends that preference shareholders are ahead in the queue for.

If a company ceases business or liquidates, it must pay its preference shareholders before its ordinary shareholders.

There’s more than one type of preference share

Most preference shares are irredeemable. What this means is that the company won’t pay the money a shareholder invests to buy it back.

Some preference shares are cumulative. What this means is if a company misses a dividend payment, it must pay the preference shareholders back these arrears before it can pay ordinary shareholders.

You also get participating preference shares. These shares get a share of any growth in a company’s profits over a certain level.

And there are convertible preference shares. You can convert these preference shares into ordinary shares at or between set dates.

The risks of investing in preference shares

Investing in preference shares is like investing in bonds. Just like bonds pay out fixed interest payments, preference shares pay out fixed dividends.

But they’re more risky than bonds.

To reflect the higher risk investors take on buying preference shares, they tend to offer higher yields to reflect this.

So there you have it, what preference shares are.

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