Preference Shares

There was an article in OCBC on Investing for Ladies, which focus on preference shares as a source of income for ladies.

What are Preference Shares?

For the uninitiated, the shares that are normally traded on the exchanges are common shares of a company. Preference Shares work slightly differently from these Common Stock.

1) Preferred Stocks receive dividends before Common Stocks. Therefore, you can say that you are first in line to obtain a share of the earnings from the company.

2) In times of insolvency, Preference Shares are entitled to a share of the assets after the debtors have been paid, and receive it before Common Stockholders.

3) Preference shares provide guaranteed dividends should the company announce that dividends are to be paid out to the shareholders. Since dividends are essentially guaranteed, the price fluctuations of the Preference Shares is usually lower than Common Shares. Take note however, that there may be certain occasions that the company does not declare dividends for the year, and you will not be able to obtain your payout. These occasions are few and far between.

What does these all mean? For example, if Company A has a preference shares that is labelled Company A 5% NCPS, it means that should Company A announce the distribution of dividends to Common Shareholders, Preference Shareholders will be entitled to 5%p.a. of the offer price of the security (you can find this information on SGX). As such, Preference Shares can be considered as a fixed income security.

For the Kiasu Singaporean, it just means that you are always at the front of the queue for the dividend payout.

Why Invest in Preference Shares?

For more risk averse people, Preference Shares provide a source of fixed income. This form of passive income appeals to them as the risks are low. I encourage people who have spare cash lying around to invest in Preference Shares.

Furthermore, compared to fixed deposits or investment linked insurance, Preference Shares are more liquid, as one can sell of the shares in order to obtain your investment, which most of the time would be almost equal to the initial investment.

Risks of Preference Shares

There are occasions when Preference Shares become totally worthless. For example, Citigroup's Preference Shares were excellent to hold onto, but since the financial crisis, the Preference Shares are essentially worthless because the main attraction, and thus price, of the Preference Shares are determined by the dividend payout. Since Citigroup is unable to announce dividends, the Preference Shares have become worthless.

Furthermore, as Preference Shares show little signs of capital appreciation, during a bull run, preference shares may not provide a large return as compared to Common Stock. Another point to note is that Preference Shares does not give you voting rights. That is a small tradeoff for a fixed income, don't you think?

Having said that, as I am more of a risk taker, I do not advocate dividend investing. However, for more risk averse people, Preference Shares is an excellent way to start off a portfolio for a fixed income.

This article was requested to be done for someone dear to me. Hope it will help everyone out there who are looking for passive income.