Preferred Shares 101
NON-VOTING
While both common shares and preferred shares represent a piece of ownership of a company, preferred shares do not come with voting rights. In exchange, preferred shares receive a regular dividend (where common shares might not) that is prioritized, as well as priority over common shares in liquidation should the company go bankrupt. This means that preferred shares are not dilutive to the voting interest of common shareholders.
PRIORITIZED
We’ll dive into everything about dividends in a moment, but I want to talk briefly about that concept of priority. It’s easy to overlook priority and take it for granted when times are good and money is plentiful: everyone gets paid something, and nobody is left wanting. But when times are tough, or cashflow is tight for any number of reasons, the priority that prefs take over common shares can become quite important. In this sense, priority means that the preferred shares get paid first, in their entirety, before dividends can be declared on the common shares. You can see how this could get important as the “glass of income” moves from half-full to half-empty.
DIVIDENDS
Investors like preferred shares for the ability to earn passive income in the form of dividends, but there are a few important terms that apply to the dividends that can really change the nature of the deal for a potential investor. The actual amount of the dividends can be fixed (like a stated amount) or floating (tied to some benchmark rate), and are expressed as a percentage of the offer price. This is known as the “yield” and is the expected annual return. As we’ve covered with REITs, the yield of a preferred share goes up as the price of the share goes down, and the yield goes down as the price of the share goes up.
“Perpetual/Term”
Preferred shares that are listed on the PSE tend to be “perpetual”, which means that they will pay out a fixed dividend indefinitely until they are redeemed according to the redemption terms of the particular deal. Prefs that are not perpetual have a term, and “mature” at the end of the term to return the face value of the preferred share plus any owed dividends.
Call options / redemption
Some preferred shares come with build-in redemption schedules, where the company will pay some premium over the IPO price to buy the preferred shares back from the shareholder. Like in the 2nd to 3rd year, the company will pay 102% of the purchase price, but in the 4th to 5th year only 101% of the purchase price.
“Step-up rate”
Most preferred shares will include a step-up rate, where the dividend paid will increase on a given date (like the 4th anniversary of the IPO) if the preferred shares have not been redeemed by that time. An example step-up term might be: “On the 5th year, higher of 7.5% or 10-year BVAL average plus 6.0%”.
“Cumulative/Non-cumulative”
If the prefs are “cumulative” and the company misses a dividend payment, the declared-but-missed dividends will be carried forward indefinitely, and the preferred shareholder will receive priority for the missed dividend and the regular dividend before any dividends can be declared on the common shares. If the prefs were “non-cumulative”, the priority over the common would only apply for missed payments in the current year. Preferred shares are normally cumulative.
“Participating/Non-
If preferred shares are “participating”, this means that they will also receive dividends that are declared on the common shares of the company. “Non-participating” just means that the preferred shares will not receive their own dividends, plus the dividend declared on the common shares. Preferred shares are normally non-participating.
“Convertible/Non-convertible”
Sometimes, preferred shares come with the right to convert the preferred shares into common shares, usually with a conversion ratio. We saw this most recently with Cebu Pacific [CEB] and its preferred share sale that allowed buyers to convert their CEBCP shares to common shares. Preferred shares are normally non-convertible.
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