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Preference shares: An unusual source of investment income

by , 22 October 2013
Preference shares: An unusual source of investment income
If you're looking for an alternative way to generate an income, then preference shares might be what you're looking for. If you like the idea of investing for dividends, but want to do this is a less risky way, preference shares offer you this alternative. Let's take a closer look at preference shares, an unusual source of investment income...

Many private investors have never heard of preference shares (or ‘prefs’) - but what are they, exactly?

They are a special type of share issued by some companies.

A preference share is so-called, because you get preferential treatment compared with ordinary shareholders. You get paid your dividends before them. Also, if the company goes bust, you will get your share of any money left before the ordinary shareholders do.

It’s worth remembering that a preference share dividend is paid out of a company’s post-tax profits and is usually fixed. If the company grows its profits, your dividend will not increase. It will remain the same.

Preference shares are less risky than normal shares

In some ways, this makes it more like owning a bond rather than a share. But your investment is less risky than a normal share.

A company cannot pay a dividend to ordinary shareholders unless the preference dividend has been paid first. And in the case of a cumulative preference share, if any year’s dividend payments are missed, then they must all be paid before any dividends are paid to ordinary shareholders.

There aren’t many preference shares available. But you can buy them easily through your stockbroker. Some of the dividends can be quite high and relatively safe, as they only require a small amount of the company’s profits to pay them (there are fewer preference shareholders, so the overall payout is much lower than the ordinary dividend).

It can often be a better – and safer – strategy to buy the preference shares of companies such as banks or insurance companies, where the ordinary dividends could be less secure.

But beware, there can be big differences between the buying and selling price of the share. Always calculate the income return you are getting by dividing the dividend you receive by the price you will have to pay.

Also find out whether the company has the option to buy back the preference share. This is the case with redeemable preference shares.

It can also be a good idea to avoid the preference shares of companies with too much debt.

So there you have it, preference shares, an unusual source of investment income.

Preference shares: An unusual source of investment income
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