Preferred shares - the middle child
For business owners, you may already know the difference between regular shares and preferred shares: common shares get votes and appreciation in value while preferred shares likely have no say in the company but will reap the rewards of good management by way of dividends. Preferred shares, also known as preferred stock, are a type of ownership in a company that have certain privileges over common shares. These privileges can include a fixed dividend payment and priority in the event that the company goes bankrupt and distributes its assets.
Preferred shares are often seen as a hybrid between stocks and bonds. Like stocks, they represent ownership in a company and have the potential to increase in value if the company performs well. Additionally, like bonds, they also offer a fixed income in the form of dividends. This makes preferred shares an appealing investment for those who want the potential for capital appreciation but also want some stability and income.
One key difference between preferred shares and common shares is that preferred shareholders do not have the same level of ownership and control as common shareholders. Common shareholders have the right to vote at shareholder meetings and have a say in the management of the company, while preferred shareholders generally do not have these rights. However, preferred shareholders do have a higher claim on the company's assets and earnings than common shareholders, which makes them a more secure investment.
The two main types of preferred shares are cumulative and non cumulative. Cumulative preferred shares are a type of preferred share that gives shareholders the right to receive any missed dividends before common shareholders receive any dividends. This means that if the company fails to pay dividends on its preferred stock in any given year, the cumulative preferred shareholders are entitled to receive those missed dividends before the company can pay dividends to common shareholders. If the company does not have sufficient profits to pay the cumulative preferred dividends, it must carry over the unpaid dividends to future years until they are paid while regular preferred shares do not have this requirement. Due to the lack of guarantee on non cumulative preferred shares, companies need to offer higher dividends to make them an attractive investment and because of this most companies prefer to issue shares with the cumulative feature to pay a lower dividend.
Preferred shares can be tough to buy for investors because most people that buy them want to hold on to them for the income. That means that they don’t trade as much as their common stock counterparts, and so you may have to pay a little higher price to buy or accept a lower price to sell. It’s for this reason that most individual investors buy preferred share ETFs. Not all ETFs are created equal. Some have higher fees than we think is necessary or get filled up with non-cumulative preferred shares, which we do not like. Want to know our favourite preferred shares or preferred share ETFs?
Sources:
https://www.forbes.com/advisor/investing/what-is-preferred-stock/
https://corporatefinanceinstitute.com/resources/equities/preferred-shares/