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What is a preferred share?

 Preferred shares are a type of investment with features that make it partly like debt (fixed income investments) and partly like equity investments (potential appreciation). They entitle investors to receive dividends before the company can pay dividends to investors who hold common shares, but do not entitle preferred shareholders to elect directors or vote on most other corporate decisions. Preferred shares also provide priority over common shareholders on assets, should the company stop carrying on its business and sell its assets.  

There are many different terms attached to preferred shares. Some are perpetual preferred shares with no fixed maturity date. Others are term preferred shares, which the company plans from the outset to buy back at a fixed date. Although most have a fixed dividend, others have a floating rate that moves with the prevailing interest rates. Make sure you understand the various special benefits and the restrictions for any preferred shares you buy.

What risks does it have?

A preferred share is a medium-to high-risk investment. It isn’t as risky as common shares of the same company but more risky than fixed income investments, like GICs and most government bonds.

The most significant risk of a preferred share is that the company may reduce or suspend dividend payments if it isn’t making enough money to pay them. If the company does that, the price of the preferred shares will fall. The preferred share terms will indicate whether the dividends are cumulative or not. If not, the company won’t pay you any unpaid dividends, even if it makes enough money to resume paying dividends in the future.

Companies that issue preferred shares promise to pay dividends to preferred shareholders before they pay any dividend to common shareholders. These dividends are normally fixed. If the company runs into financial trouble, it may stop paying dividends on its preferred shares. Indeed, it must stop paying any dividends if it is unable to pay its debts as they come due.

Another risk of preferred shares is price fluctuation, although share prices don’t usually fluctuate as much as the price of common shares. The effect of a drop in price is the same as for a common share.

Also, the company might fail. If so, you risk losing all the money invested. Because you don’t have voting rights you won’t be in a position to influence the company.

Some preferred shares that do not trade on a stock market but may be listed on the over-the-counter market. They come with additional risks, such as the difficulty in finding out the appropriate price for the share, and finding a buyer for shares that you are trying to sell.

If you are considering investing in the preferred shares of a private company, there are many more risks to consider.

Can you sell them easily?

Possibly. Many preferred shares trade on a stock exchange, but they tend to be thinly traded because there are fewer buyers and sellers in the market for preferred shares compared to common shares. You may not be able to sell your shares when you want.

It will be harder for you to follow the price of your preferred shares, and may be harder to find a buyer, if the shares trade on an over-the-counter market. It will be harder still to sell your shares if they do not trade on any market at all.

What are the associated costs?

The only cost of investing in preferred shares is paying a purchase or sale commission or paying a fee to your advisor to manage your account. There should be no ongoing costs.

What are the expected types of returns?

There are two ways to make money on preferred shares: dividends and/or price appreciation.

Like common shares, you’ll get capital gains if you sell your shares for more than you paid for them, or capital losses if you have to sell when the price of the shares has decrease. Since the prices of preferred shares do not fluctuate as widely as common shares, you are unlikely to receive a big capital gains or capital losses.