What is Preference Shares Meaning? Types of Preference Shares and Cumulative Preference Shares

If you want to invest in the stock market, then you will come across different types of shares. Most people may be somewhat familiar with how common stocks work, but very few people know about preference shares.

If the first thought you have when you hear this term is ‘What do you mean by preference share?’ then don’t be alarmed! Everything you need to know about this specific class of shares will be covered in this article.

We will discuss preference shares meaning, the different types of preference shares, and what being a preference shareholder means. By the time you finish reading, you will know to purchase preference shares with ease!

Before we can understand what a preference share is and how it's different from an ordinary share, we need to establish how shares work.

If you buy a company's stock, you are contributing to its success by providing capital. This entitles you to a share of the company's profits.

Companies pay their shareholders an annual sum as a return on their investment. This is known as a dividend payment.

Let's say a company offers two types of shares, ordinary shares, and preference shares. The main advantage that preference shares provide over their ordinary counterparts is that preference shareholders are entitled to receive dividend payments before ordinary shareholders.

Companies decide to issue preference shares when they need funding to expand their business. This is known as preference share capital.

A preference share provides the holder with a safety net because if a company incurs losses or is about to go bankrupt, then being a preference shareholder means the individual will receive their owed amount before an ordinary shareholder, who may not receive his owing at all!

Convertible preference shares are preference shares that are readily convertible into preference share capital. Sometimes preference shares yield dividends in installments; these incremental preference shares are termed cumulative preference shares.

In India, preference shares must be redeemed after twenty years of issue; these shares are known as redeemable preference shares.

The Firms Act of 2013 prohibits companies in India from issuing irredeemable preference shares.

There are many different types of preference shares. As you already know by now, preference shares have some key characteristics that ordinary shares don’t, and vice versa.

However, firms have introduced special types of preference shares that offset some of the disadvantages of holding this type of stock.

For example, if you want to have to option of converting your preference share into an ordinary one, you can purchase convertible preference shares. Convertible preference shares are a type of share that is readily convertible into common stock.

You have to be aware that you will also come across non-convertible preference shares that can't be converted into common shares. So, keep this in mind and purchase the type that suits your needs.

If you think owning a certain company’s stock carries some risk, you have offset this by purchasing redeemable preference shares. Redeemable preference shares may be bought back or redeemed at a specified value and timeframe by the issuing firm. These shares provide a buffer for the corporation during periods of high inflation.

Non-redeemable preference shares are shares that don't have to option of being redeemed or bought back at a specified schedule by the issuing business. Non-redeemable preference shares serve as a safety net for corporations during inflationary periods.

Types of Preference Shares

As we discussed earlier, preference shares enable the holder to have a safety net if that company is ever liquidated. This ensures that you will be paid back on your investment. If you want to have this option, you need to purchase some participating preference shares.

Participating preference shares enable owners to claim a portion of the firm's residual revenue upon insolvency, once dividends have been distributed to ordinary investors. Nonetheless, these stockholders get regular payments and share in the firm's excess profits with equity stockholders.

The owners of non-participating preference shares do not have the flexibility of receiving profits from the firm's excess earnings, but they do get set dividends from the corporation.

Cumulative preference shares are a form of stock that entitles owners to accumulate dividend payments from the firm, regardless of whether or not they are earning a profit.

In years in which the firm does not generate revenue, these payments will be recorded as payables and distributed on an accumulated basis the following year, or whenever the company earns a profit.

With non-cumulative preference shares, dividend payments are not collected in arrears on stocks. In the event of such classes of stock, the dividend payment is derived from the firm's current-year earnings.

Therefore, if a firm does not generate a profit in a given year, the shareholders will not get any dividends. Additionally, they cannot collect payouts in any subsequent year or earnings.

The last type of preference share is adjustable preference share. This type is unique because the payout rate for adjustable preference shares is not set and is affected by market conditions.

Several characteristics of preference shares have enabled ordinary investors to generate greater returns even during periods of sluggish economic development. One of the most enticing characteristics of preference shares is that they may be exchanged for common stock.

It is simple to exchange preference shares for ordinary stock. If an investor wishes to alter their holdings, they are changed into a set number of preference shares.

Certain preference shares notify shareholders that they may be exchanged after a certain date, but others may need the consent and authorization of the corporation's board of directors.

Preference shares enable owners to receive dividends even while other shareholders may get payments delayed or not at all. Compared to equity and other shareholders, preference shareholders have the significant benefit of getting dividends first.

Preference shareholders have voting rights in the event of exceptional occurrences. Nevertheless, this only occurs in specific instances. In most cases, acquiring a firm's shares does not provide voting rights.

In the event of a firm's insolvency, preference share payments take precedence over non-preferred stockholders when negotiating the assets of the company.

Purchasing preference shares is the same as purchasing ordinary stock. You'll need to have a brokerage account to enter the marketplace. The brokerage may then be browsed for particular securities.

These preference securities may be offered independently from common equities, so you may need to use a separate screening tool or go to a different portion of the brokerage's website.

Verify the brokerage's offers before establishing an account since not all firms provide accessibility to the same stocks.

Preference shares are included with other kinds of investor ownership on the balance sheet of a company.

Ordinary shares and preference shares are normally segregated on the financial statements, however, they will show side-by-side under the sections for liabilities and shareholder equity.

Preference shares are a hybrid commodity in the finance world, as they combine both equity and debt.