Investing in preferred shares: which type should you consider?

When it comes to investing, not all shares are created alike – especially preferred shares. What are some common types and how could they work in your favour? We'll tell you.

Preferred shares pull rank on common shares. That means people who own preferred shares are senior equity holders. As such, if the company goes bankrupt they will get paid their dividends first and will also cash out before common shareholders.

There are many kinds of preferred shares with varying terms and structures:

“Straight” or “perpetual” preferred shares

• Has no fixed maturity date.
• It pays its stated dividend forever, or “in perpetuity.

“Retractable” or “term” preferred shares

• Has its maturity set at issue. A five-year retractable preferred, for instance, would have a $25 “par value” which would be repayable by the issuer five years from the date of issue.

“Soft-retractable” preferred shares

• It is a preferred share that has its retraction value payable in “hard cash,” or in an equal value of common stock of the issuer. How you get paid is up to the issuer.

“Fixed-rate” preferred shares

• Includes a set or “fixed-rate” dividend upon issue, usually declared and paid quarterly.

“Floating-rate” preferred shares

• Provides for a dividend that is paid by reference to a market interest rate.

“Dutch auction” preferred shares

• Has its interest rate set as the outcome of a “reverse auction,” where bidders indicate the interest rate that they are willing to accept.
• The bids are then examined and the highest bid “clears” the auction.

While they receive preferential treatment, preferred shareholders actually rank below debt holders. How so?

• If an interest payment is missed, the debt holders can actually force the company into default.
•  A company’s board can also decide not to pay a preferred dividend if the company can’t make those payments.

Most preferred shares are “cumulative,” so missed dividend payments are accumulated until they are finally paid – at which point all the missed dividends have to be paid on the preferreds before anything goes to the common shareholders.

Preferred shares can offer some protection against market setbacks. What's more, they do come with certain upgrades when compared to common stock.

• Keep in mind that while they can be a useful part of any portfolio, preferred shares should really be seen as one of the many pieces of your overall investment puzzle.

Smart Tip provided by The Financial Pipeline. Founded in 1996 by a group of portfolio managers, The Financial Pipeline is dedicated to providing financial knowledge and education to anyone and everyone with even a passing interest in finance. Our motto, “Financial Information For the Rest of Us,” speaks for itself.