There are some types of investment options for those who want to make money through the equity markets. For most people, the go-to asset will be common stocks. However, preference shares are also very good options. They also come in different forms.
What are Preferred Stocks?
Preference shares, or, more commonly, preferred stocks, are called like that because preferred shareholders hold the higher claim on the company’s assets than common stockholders.
In the case of bankruptcy or liquidation, preferred stockholders must be paid for their interest in the company before any other common stockholder.
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Practically, this means that preferred stockholders have the guarantee of dividend payments, which common stockholders don’t have.
The catch is that preferred shareholders do not have any voting rights, which common stockholders have.
Callable shares are one type of preferred stocks which the company can buy back at a fixed price in the future.
This kind of preferred stock has more benefits to the company than to the shareholders as it basically enables the company to put a lid on the value of the stock.
Say, for instance, that the company retains the right to buy a callable share back at $30 per share. It may want to buy out the shares from shareholders at this price if the market value of preferred shares appears to be increasing above this level.
Callable shares guarantee that the company can put a cap on the maximum liability to preferred shareholders.
Convertible shares, meanwhile, are preferred stocks that the investor can exchange for common stocks at a fixed rate. This setup can be advantageous to the shareholder if the market value of common shares goes up.
Say, for example, that an investor bought five shares of this kind of preferred stock at $20 per share, and one share of preferred stock can be converted into two shares of common stock.
The investor can make a profit on the initial $100 investment if the five preferred shares are converted into ten common stocks when the value of common shares move higher than $20.
After the shares have been converted, the investor then has to give up the benefits of a fixed dividend. He or she also cannot convert common shares back to preferred shares.
Cumulative preferred stocks are those that protect the investor against a potential downturn in company profits.
If the revenues are down, the issuing company may find it difficult to pay dividends. Cumulative shares require the company to pay unpaid dividends to preferred shareholders before any dividends can be given to common shareholders.
If the company guarantees dividends of $10 per preference shares but cannot pay for three years in a row, it must pay $40 cumulative dividend in the fourth year before any other dividends can be paid.
Participatory Preferred Shares
Participatory preferred shares offer an additional profit guarantee to shareholders. All preference shares provide a fixed dividend rate, which is their primary benefit.
On the flipside, participatory shares guarantee additional dividends in such times that the company meets a certain financial goal.
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