What Are Preference Shares? Everything You Need to Know Before Investing

Investors have many choices when it comes to building wealth. Beyond ordinary shares and bonds, companies also issue preference shares, sometimes called preferred stock. These instruments offer a balance between equity and fixed income, making them an attractive option for those seeking stability and steady returns. In this article, you will learn what preference shares are, how they work, their advantages and disadvantages, and how you can trade them through VT Markets, supported by real-life examples and figures.

What Are Preference Shares (Preferred Stock)?

Preference shares, also called preferred stock, are a special class of equity issued by companies to raise capital. They sit between bonds and ordinary shares in terms of risk and reward. Like ordinary shareholders, preference shareholders are part-owners of the company, but unlike them, they usually do not have voting rights in company decisions.

What makes preferred stock unique is its predictable dividend stream and priority status. Holders receive a fixed dividend before any payment is made to ordinary shareholders, and if the company faces liquidation, preference shareholders have a higher claim on the company’s assets. This makes them less risky than ordinary shares but not as secure as bonds.

Key characteristics include:

• Fixed dividend payments that are often higher than ordinary share dividends.
• Priority over ordinary shareholders for dividends and asset claims.
• Hybrid nature, combining features of debt (steady income) and equity (ownership).
• Limited or no voting rights, meaning less influence on company policies.

Example:

Suppose a company issues preference shares with a fixed 6% annual dividend. If an investor buys $10,000 worth of these shares, they receive $600 each year. Even if the company decides not to pay dividends to ordinary shareholders due to weak earnings, preference shareholders still receive their fixed payout first.

Types of Preference Shares

Preferred stock comes in different forms, each designed to meet specific needs for both companies and investors:

1. Cumulative Preference Shares

These shares allow unpaid dividends to accumulate and be carried forward to future years. This feature protects investors, since companies must pay all missed dividends before ordinary shareholders can receive any payments. For example, if a $2 dividend is skipped for three years, the shareholder is still entitled to $6 per share once dividends resume.

2. Non-Cumulative Preference Shares

With these shares, dividends are only paid out of current profits. If a company decides to skip the payment in a given year, those dividends are lost forever. This makes them riskier than cumulative preference shares, but they are still ranked ahead of ordinary shareholders in payouts. For instance, if a $2 dividend is missed this year, shareholders cannot claim it later even if profits improve.

3. Participating Preference Shares

Participating shares provide both a fixed dividend and the right to share in additional profits if the company performs exceptionally well. This allows investors to enjoy more upside than with traditional preference shares. For example, a shareholder might receive the usual 6% dividend and, in a record year, also gain an additional 2% bonus distribution.

4. Convertible Preference Shares

Convertible shares can be exchanged for a fixed number of ordinary shares after a certain period or under specified conditions. This feature gives investors flexibility, as they can keep collecting fixed dividends or convert to ordinary shares to benefit from share price growth. For instance, a $100 convertible preference share may be exchanged for five ordinary shares if the company’s stock price rises significantly.

5. Redeemable Preference Shares

Redeemable shares come with a maturity date at which the issuing company can buy them back, usually at a predetermined price. This provides investors with a clear exit strategy, although they may face reinvestment risk if market conditions change. For example, a company might issue redeemable preference shares at $100 each and promise to repurchase them after 10 years.

Preference Shares vs Ordinary Shares: Key Differences

Both preferred stock and ordinary shares represent ownership in a company, but they work very differently. Ordinary shares are the most common type of equity, giving investors full voting rights and the potential to benefit from rising profits. Preference shares, on the other hand, prioritise income stability and security by offering fixed dividends and higher claims on assets, but often at the cost of voting power and growth potential.

Example: During the 2008 financial crisis, several banks, including Citigroup, raised capital by issuing preference shares. Holders of these shares continued receiving fixed dividends and had priority in receiving dividends, even as ordinary shareholders saw their dividends suspended, highlighting the stability preference shares can provide in turbulent markets and the risk that ordinary shareholders may not be receiving dividends during periods of financial stress.

Advantages of Preference Shares

Preferred stock offers several benefits that make it appealing to certain types of investors. Their structure provides stability, priority in payouts, and a mix of bond-like and equity-like features.

• Stable Income: Preference shares usually pay fixed dividends, giving investors predictable returns regardless of market volatility. This makes them appealing to conservative investors or those relying on steady cash flow.
• Priority Over Ordinary Shares: Holders are paid before ordinary shareholders when dividends are declared and also rank higher in asset claims if the company is liquidated. This reduces overall investment risk.
• Hybrid Nature: They combine features of bonds and equity, offering fixed income like a bond while still representing ownership in the company. This balance provides both security and moderate growth potential.

Disadvantages of Preference Shares

Preferred stock also comes with drawbacks that limit its appeal. Their fixed structure means less growth potential, limited rights, and possible liquidity concerns.

• Limited Voting Rights: Preference shareholders usually have little to no say in company decisions, which means they cannot influence management or policy like ordinary shareholders can.
• Lower Growth Potential: Dividends are fixed, so investors miss out on the potential gains from rising profits and share prices that ordinary shareholders may enjoy.
• Liquidity Risk: Preference shares are often less actively traded than ordinary shares, which can make it harder for investors to sell quickly or at favourable prices.

Who Should Invest in Preference Shares?

Preferred stock is best suited for investors who value stability and steady returns rather than high-risk, high-reward opportunities.

• Income-Focused Investors: Those who rely on predictable dividend payments, such as retirees, benefit from the fixed payouts of preference shares.
• Conservative Investors: People who want less exposure to market volatility may prefer the stability that preference shares provide compared to ordinary shares.
• Institutional Investors: Pension funds and insurance companies often include preference shares in their portfolios to balance income with moderate risk.
• Diversified Investors: Individuals who already hold higher-risk assets, such as growth stocks, may use preference shares to stabilise overall returns.
• Long-Term Holders: Investors comfortable with limited liquidity and fixed income may see preference shares as a dependable option for holding over time.

How to Trade Preference Shares with VT Markets

At VT Markets, you do not purchase preference shares directly. Instead, you can trade them through Contracts for Difference (CFDs), which let you take advantage of price changes without owning the actual shares. This gives you flexibility to profit in both rising and falling markets.

Step 1: Learn the basics

Understand what preference shares are, how fixed dividends work, and why they differ from ordinary equity.

Step 2: Create your trading account

Sign up with VT Markets and finish the quick verification process to start trading.

Step 3: Fund your account

Deposit fund into your trading account using safe and convenient funding methods.

Step 4: Select a preference share CFD

Pick the company you want to trade, such as major banks or global corporations that issue preference shares, and review its market outlook.

Step 5: Execute your trade

Decide whether to buy (go long) if you expect prices to increase, or sell (go short) if you expect them to decline.

Learn the difference between going long and going short. 

Step 6: Implement risk management

Use risk management tools such as stop-loss orders, take-profit levels, and position sizing to manage potential losses and protect your capital.

Step 7: Stay informed

Keep track of company earnings, interest rate trends, and broader market news, as these factors can influence preference share prices.

New to trading? Discover how to start as a beginner.

Summary

What are preference shares? They are hybrid instruments that provide fixed dividends and priority in payouts, making them attractive for income-focused and conservative investors. While they lack voting rights and offer limited growth compared to ordinary shares, they deliver stability and reduced risk. Through VT Markets, you can access preference shares via CFDs on global shares, giving you flexibility to speculate on price movements while managing risk effectively.

Explore the Share Market with VT Markets

VT Markets provides a secure, innovative trading platform where you can access CFDs on global shares, commodities, indices, and more. Whether you are exploring preference shares, ordinary stocks, or other markets, VT Markets offers competitive spreads, support through the Help Centre, and powerful trading tools like MetaTrader 4 (MT4) and MetaTrader 5 (MT5). You can also practise risk-free with a VT Markets demo account before moving to live trading.

Start trading today with VT Markets and experience a trusted platform designed to help you achieve your investment goals.

Frequently Asked Questions (FAQs)

1. What do preference shares mean?

Preference shares, also known as preferred stock, are a type of equity that pays fixed dividends and gives shareholders priority over ordinary shareholders for payouts and asset claims.

2. Are preference shares safer than ordinary shares?

Yes, they are generally safer because they pay fixed dividends and rank higher in asset claims, though they are not risk-free.

3. Do preference shareholders have voting rights?

Usually no. Preference shareholders typically have little to no voting power in company matters.

4. Can preference shares be converted into ordinary shares?

Some types, called convertible preference shares, can be exchanged for ordinary shares at predetermined terms.

5. Are dividends on preference shares guaranteed?

Dividends are fixed but not always guaranteed. If unpaid, cumulative preference shares allow dividends to accrue, while non-cumulative ones do not.

6. Do preference shares trade on stock exchanges?

Yes, but they are often less liquid than ordinary shares, meaning fewer buyers and sellers may be available.

7. How do preference shares compare with bonds?

Both provide fixed income, but bonds are debt while preference shares represent equity ownership. Bonds usually rank higher in repayment if a company fails.

8. Why do companies issue preference shares?

They allow firms to raise capital without giving away voting control, often making them attractive for banks and large corporations.