We explain how they work and why they differ to ordinary shares
Thursday 29 Jul 2021 Author: Daniel Coatsworth

Most stocks owned by retail investors are classified as ordinary shares, giving you part ownership of a company, the right to vote and receive any dividends declared. However, there is another category of share to explore.

Preference shares might appeal to investors who are looking for stable income and an alternative to bonds.

Investors owning these shares receive a fixed dividend payment each year. They are ahead of ‘ordinary’ shareholders in the queue to be paid, but all types of shareholder will be paid after creditors of the company.

The benefit of owning these types of shares is that you will be ahead of ordinary shareholders for a claim on assets in the event the company goes bust. However, preference shareholders typically won’t receive a vote at the annual shareholder meeting, so you won’t have a say in how the company is run.

Voting rights can be activated if the company does not pay a dividend for a substantial period, which is defined in the company’s ‘article of association’, a document found in the investors’ section of the company’s website.

While it is generally said that preference shares have a fixed dividend, sometimes that is not true. ‘Participating’ preference shares give the shareholder the right to further dividends if the company is successful.

For example, one year the company might pay 6p per share to ordinary shareholders and the same to preference shareholders. The following year, the company pays 10p per share to ordinary shareholders but only 6p per share to those holding preference stock.

In this case, the higher dividend for ordinary shareholders might trigger the right for the participating preference shares to also get a bit extra – but not necessarily the full amount.

If dividends cannot be paid in a particular year, such as if the company has insufficient profits, preference shareholders would receive no dividend. However, if they owned ‘cumulative’ preference shares then the dividend entitlement accumulates.

If the company has made sufficient profits, the cumulative preference shareholders will have the arrears of dividend paid in the subsequent year. If the shares were non-cumulative, the dividend from the first year would be lost.

Some well-known companies on the stock offer both types. For example, copper miner Antofagasta has ordinary shares (ANTO) and preference shares (70GD).

A few investment trusts do the same, such as City of London Investment Trust which has ordinary shares (CTY) and preference shares (BA69).

While dividend yields can sometimes be higher, a key downside of preference shares is that you may not get as much capital growth as with ordinary shares.

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