Preferred shares: what are they?

Just as the name suggests, preferred shares are a type of security in which shareholders receive preferential treatment over common shareholders when receiving dividends or in the event of a company liquidation. For example, if a company gets liquidated, the preferred shareholders would normally have priority in claiming remaining assets over common stockholders, ensuring they receive their share before the common shareholders. Let’s dive more into it.

What are preferred shares?

Preferred shares represent ownership in a company and are a type of stock that pays dividends to shareholders before common shareholders. Unlike common shares, they do not offer voting rights and are often seen as a hybrid between stocks and bonds. They are usually issued at a fixed price and can be purchased through a broker or financial advisor. Most businesses that issue these shares are usually larger in size and have a solid financial track record. Examples of companies that issue preferred shares, without limitation, include Bank of America (BAC.US), General Electric (GE.US), and JPMorgan Chase (JPM.US). 

Common shares differ from preferred shares in that they typically offer voting rights, have potential for capital appreciation, may or may not pay dividends, have lower priority in receiving dividends and assets during liquidation, and are generally considered riskier but with higher potential returns.

Types of preferred shares

There are various types of preferred shares, each offering different characteristics and benefits. Here are some examples:

1. Cumulative preferred shares: These shares allow missed dividend payments to accumulate and must be paid in the future before common shareholders receive dividends.
2. Non-cumulative preferred shares: Unlike cumulative shares, missed dividend payments do not accumulate and are not required to be paid in the future.
3. Convertible preferred shares: These shares can be converted into a predetermined number of common shares at the option of the shareholder. This provides a chance for potential capital appreciation.
4. Callable preferred shares: The issuing company has the right to redeem these shares at a specific price and date, providing flexibility for the company but potentially disadvantageous to investors.
5. Adjustable-rate preferred shares: These shares have variable dividend rates that adjust based on changes in a benchmark interest rate, such as the prime rate or treasury rate.
6. Participating preferred shares: Shareholders of participating shares have the right to receive additional dividends beyond the fixed rate if the company exceeds specified profit thresholds.
7. Perpetual preferred shares: These shares have no maturity date and continue indefinitely, typically paying fixed dividends.

Why is it important for traders?

Preferred shares could be important for traders due to several reasons:

1. Dividend priority: Preferred shareholders have priority when it comes to receiving dividends. They are entitled to receive dividends before common shareholders, which could provide a steady income stream for traders who rely on dividend payments.
2. Capital preservation: They generally offer more stability compared to common shares. They have a fixed dividend rate and higher claim on the company's assets in case of liquidation. This could be attractive to traders looking for investments with lower risk and potential capital preservation.
3. Potential for conversion: Some types of preferred shares, such as convertible preferred shares, could be converted into common shares at the option of the shareholder. This provides traders with the potential for capital appreciation if the value of the underlying common stock increases.
4. Interest rate sensitivity: Adjustable-rate preferred shares could be appealing to traders who want exposure to interest rate movements. These shares have variable dividend rates that adjust based on changes in benchmark interest rates, offering the chance for potential gains if rates rise.
5. Diversification: Including preferred shares in a trader's portfolio could help diversify their holdings. By adding a different asset class, traders could potentially reduce risk and achieve a balanced investment strategy.

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