When it comes to investing in the stock market, one of the key investment options that investors can choose from is preference shares. Preference shares are a type of security that combines features of both equity and debt. Essentially, preference shares are equity shares that come with additional features such as preferential dividend payments and priority in case of liquidation. In this article, we will cover everything you need to know before investing in preference shares.

What are Preference Shares?

Preference shares are a type of security that represents ownership in a company but with different characteristics than common shares. As the name suggests, preference shares give their holders preferential treatment when it comes to certain aspects of the company. For example, preference shareholders receive a fixed rate of dividend payment before common shareholders receive theirs. Moreover, in case the company is liquidated, preference shareholders have priority over common shareholders when it comes to receiving their share of the proceeds.

Types of Preference Shares

Cumulative and Non-Cumulative Preference Shares

In the case of cumulative preference shares, if the company fails to pay the preferred dividend in any year, the unpaid amount accumulates and has to be paid before any dividends are paid to the common shareholders. On the other hand, in the case of non-cumulative preference shares, if the company fails to pay the preferred dividend in any year, the unpaid dividend is not carried forward to be paid in future years.

Convertible and Non-Convertible Preference Shares

Convertible preference shares can be converted into equity shares after a certain period of time, or after certain conditions have been met. On the other hand, non-convertible preference shares cannot be converted into equity shares, they remain as preference shares until they are redeemed.

Participating and Non-Participating Preference Shares

Participating preference shareholders are entitled to receive not only the fixed preference dividend but also to share in the profits of the company along with the equity shareholders. On the other hand, non-participating preference shares are only entitled to receive the fixed preference dividend and no further benefits.

Benefits of Preference Shares

Steady Income

One of the key benefits of investing in Preference Shares is that they provide a steady stream of income. As preference shareholders receive a fixed rate of dividend before common shareholders, they are in a better position to receive the dividend even when the company is not performing well.

Priority in Liquidation

Another key benefit of investing in preference shares is that in case of liquidation, preference shareholders have priority over common shareholders when it comes to getting their share of the proceeds. This means that in case the company is liquidated, preference shareholders are likely to receive their due before common shareholders.

Limitations of Preference Shares

Fixed Returns

One of the major limitations of investing in Preference Shares is that they offer fixed returns. Unlike equity shares, preference shares only offer a fixed rate of dividend that may not change even if the company is performing exceptionally well. This means that preference shareholders may miss out on additional dividends or returns that they could have received if they had invested in equity shares.

Risk of Capital Loss

Another limitation of investing in preference shares is that they are not completely immune to the risk of capital loss. Although preference shareholders are in a better position compared to common shareholders in case of liquidation, they are still exposed to the risk of capital loss if the company performs poorly over a long period of time.

Conclusion

Investing in preference shares can be a good option for investors who are looking for a steady stream of income and preferential treatment in case of liquidation. However, as with any investment, it is important to carefully evaluate the pros and cons before investing. Investors should always consult with a financial expert before making any investment decisions in the Indian share market.

Disclaimer: The information provided in this article is for informational purposes only and should not be considered investment advice. Investing in the Indian stock market involves risks and investors should carefully evaluate their financial situation and goals before making any investment decisions.