Preference shares (also called preferred stock) are equity securities that sit between bonds and common stock in a company’s capital structure. They typically pay a fixed dividend that must be satisfied before any dividend is paid to common shareholders, but they usually carry limited or no voting rights. On bankruptcy or liquidation, preferred shareholders have a higher claim on assets than common shareholders but rank behind creditors (lenders and bondholders).
Key takeaways
– Preferred shares combine features of equity (ownership) and fixed‑income (fixed dividend).
– Common variants include cumulative, non‑cumulative, participating and convertible preferreds; others include callable/redeemable and floating‑rate preferreds.
– Preferred dividends are usually fixed and often paid before common dividends; however, dividends can be suspended (depending on the type).
– In liquidation, preferreds are paid before common stock but after debt holders.
– Preferreds are interest‑rate sensitive like bonds, and many carry call risk, limited upside, and tax/structural nuances investors should evaluate.
Understanding the main types of preferred shares
– Cumulative preferred
• Missed dividends accrue as “dividends in arrears.” The company must pay accrued dividends to cumulative preferred holders before common dividends can be resumed. This makes cumulative preferreds comparatively more protective for income investors.
– Non‑cumulative preferred
• Missed dividends are lost and do not accumulate. If the board skips a dividend, holders cannot claim it later.
– Participating preferred
• Pays the stated preferred dividend and may also participate in additional dividends or liquidation proceeds according to a pre‑set formula (for example, receiving extra dividends if common shareholders receive more than a certain amount).
– Convertible preferred
• Gives holders the option to convert preferred shares into a specified number of common shares, typically after a set date. Conversion value depends on the common stock’s performance.
– Callable/redeemable preferred
• Issuer has the right to redeem (call) the shares at a specified price after a certain date. Callability caps upside and introduces reinvestment risk (issuer calls when rates fall).
– Floating‑rate and adjustable preferreds
• Dividend resets periodically based on a reference rate (e.g., LIBOR, SOFR) plus a spread, reducing sensitivity to interest‑rate moves.
How preferred dividends work
– Most preferreds pay a fixed dividend expressed as a dollar amount or a percentage of par value. That dividend is typically cumulative or non‑cumulative depending on the share class. The dividend is usually paid quarterly.
– Preferred dividends are often contractually junior to debt service; they can be suspended in certain circumstances (except cumulative dividends that accrue).
Liquidation and bankruptcy priority
– Simplified priority (senior to junior):
1. Secured creditors and bondholders (debt)
2. Unsecured creditors
3. Preferred shareholders
4. Common shareholders
– Preferred shareholders share in remaining assets ahead of common holders, but they usually do not have the same rights as creditors and often recover less than bondholders.
How preferred shares are valued (high‑level)
– A perpetual preferred with fixed dividend can be valued like a perpetuity: Price ≈ Annual dividend / Required yield.
– For callable or convertible features, valuation must incorporate option value (issuer call option, conversion option).
– Preferreds’ prices move with interest rates: when rates rise, prices of fixed‑coupon preferreds tend to fall (and vice versa), similar to bonds.
– Credit quality of the issuer matters: preferreds issued by financially weaker firms trade at higher yields for the added credit risk.
Risks to consider
– Interest‑rate risk: fixed dividends become less attractive when rates rise.
– Credit/default risk: preferreds are equity claims; dividends can be suspended and principal can be lost in bankruptcy.
– Call risk: callable preferreds can be redeemed by the issuer, forcing investors to reinvest at lower rates.
– Limited upside: unlike common stock, preferreds usually have limited capital appreciation (unless convertible).
– Liquidity risk: many preferreds trade thinly; transaction costs and bid‑ask spreads can be wide.
– Tax considerations: dividend tax treatment varies by jurisdiction and by whether the issuer is a U.S. corporation, REIT, bank, etc.
Practical steps: how to evaluate and buy preferred shares
1. Clarify your objective
• Income focus, reduced volatility vs. common equity, or convertible upside? Your goal will guide the type of preferred you seek.
2. Identify the type and key terms
• Check whether the preferred is cumulative, non‑cumulative, participating, convertible, callable, or floating‑rate. These terms determine income reliability and upside potential.
3. Read the prospectus/term sheet
• Confirm dividend rate, payment frequency, call/put provisions, conversion ratio and dates, liquidation preference, and any special ranking or subordination.
4. Assess issuer credit quality
• Review the issuer’s financials and credit ratings (S&P, Moody’s, Fitch). Preferreds are sensitive to credit deterioration; yield spreads typically reflect issuer risk.
5. Calculate yield and duration
• Determine current yield (annual dividend ÷ current price) and compare with similar securities (bonds, other preferreds, dividend‑paying stocks). For fixed preferreds, consider effective duration for interest‑rate sensitivity.
6. Check call and reinvestment risk
• If callable, find the earliest call date and call price. Understand the likelihood the issuer will call the shares (higher when market rates drop below the coupon).
7. Analyze conversion mechanics (if convertible)
• Note the conversion ratio, conversion price, and any caps. Compare conversion value to current common share price to see potential upside.
8. Consider taxes and account type
• Dividend tax treatment varies. In the U.S., some preferred dividends may qualify for the lower qualified dividend tax rate; others (e.g., from REITs) may not. Consult tax guidance or a tax advisor.
9. Check liquidity and trading venue
• Preferreds trade on exchanges but liquidity varies. If buying individual issues, check average daily volume, bid‑ask spreads, and whether your broker supports trading them.
10. Decide between individual issues vs. funds
• Individual preferreds let you target specific issuers/terms. Preferred ETFs or mutual funds provide diversification and liquidity but charge management fees and can have tracking/market‑price deviations.
11. Size your position and set limits
• Because preferreds are sensitive to issuer and interest‑rate risk, limit exposure to any single issuer and set stop‑loss or monitoring thresholds.
12. Monitor regularly
• Watch issuer credit metrics, dividend payment announcements, call notices, and interest‑rate outlook. Be prepared to act if the issuer’s situation changes or the issue is called.
How preferreds fit in a portfolio
– Role: income generator with higher yield than many bonds but with equity‑like subordination.
– Allocation: preferreds can complement bonds and dividend equities, but because they are sensitive to both credit and interest‑rate risks, they are often treated separately from traditional bond allocations.
– Diversification: diversify across issuers, sectors, and preferred types (fixed vs. floating, cumulative vs. non‑cumulative).
Examples of investor choices
– Conservative income investor: cumulative, investment‑grade preferreds, or preferred funds focused on high credit quality.
– Yield‑seeker comfortable with risk: non‑investment grade preferreds or banks’ preferreds, recognizing higher yield compensates for greater credit and liquidity risk.
– Growth/income investor: convertible preferreds for fixed income‑like yield with potential upside if common stock performs.
Where to find information and quotes
– Prospectuses/registration statements filed with regulators (e.g., SEC EDGAR for U.S. issuers).
– Financial data platforms, brokerage research, S&P/Moody’s credit reports, and issuer investor relations pages.
– Preferred‑focused data providers and exchange listings for tickers and volume.
Regulatory references and further reading
– Investopedia — Preferred Stock explanation and definitions
– PwC — guidance on preferred stock dividends and accounting/treatment.
– U.S. Securities and Exchange Commission — basic investor guidance on stocks and securities filings.
– Credit rating agencies (S&P, Moody’s, Fitch) for issuer credit assessments.
– FINRA — market and trading rules relevant to over‑the‑counter and exchange‑listed preferreds.
Sources
– Investopedia — “Preference Shares / Preferred Stock” (provided source).
– PwC — “7.7 Preferred Stock Dividends.”
– U.S. Securities and Exchange Commission — “What Are Stocks?”
Editor’s note: The following topics are reserved for upcoming updates and will be expanded with detailed examples and datasets.