Preference shares are ownership security or equity. However, preference shareholders do not have any voting rights in a stockholders’ meeting. Preference shares pay dividends that are mentioned in the prospectus when the share is bought. Preference share dividends are paid before common stock dividends.
Note − Preference shares are ‘preferred’ so they need to be paid before common shares.
Yield is the effective interest rate obtained from the preference share as dividends. The yield is equal to the yearly dividend divided by the current price of the stock.
Suppose a preference share of INR 120 pays dividends of INR 50 per share. Then, the yield is 50/120 = 0.42. Multiplying by 100, we get the current yield of 42 percent.
Investors like preference shares for the inflow of income the dividends provide. In case of most preference stocks, when the company skips a dividend it accumulates, it must still pay such dividends in arrears before offering the dividends of common stock.
Preference shares carry less risk than the common stocks, as the shareowners must be paid before common stock shareholders if and when the company becomes insolvent.
There are usually some chances of growth in a preference stock's value, but it is mostly limited. Preference share prices and yields change in response to the prevailing interest rates. When interest rates go up, the prices of preference shares may fall, which lets dividend yields increase.
The reverse occurs when the interest rates fall, letting the stock price rise and the dividend yield drop.
Note − The price and yield of a preference share are related to the interest rate they offer.
It is a good practice to compare the dividend yields of preference shares to the yields of corporate bonds and other preference stock issues before making the decision to buy preference shares.
It is to be noted whether preference shares have a call provision. This essentially allows an organization to take the shares away from the market at a price determined earlier. Callable share purchasers usually pay less than non-callable shareowners. That's so because of the benefit of the issuing company, as they can essentially issue new shares at a lesser dividend payment.
Note − Preference shares with call option should be available at a lower price than non-callable preference shares. The latter’s issuing company can issue newer shares at a lower rate.