Our Recommended Broker

Get $50 in free trades.
Questrade Democratic Pricing - 1 cent per share, $4.95 min / $9.95 max FAQs
Learning Topics
Contact Us
FAQ Archive

Why would I consider investing in preferred shares?

Preferred shares offer regular income through quarterly dividend payments. If you need income from your investments, they're worth looking at.

Most companies make a point of paying dividends on their preferreds as they come due. Dividends aren't guaranteed. A company that's in financial difficulty will pay its debt obligations, such as interest on its bonds, before it will pay dividends. Preferred shareholders rank above common shareholders when it comes to payments of dividends. If the company becomes insolvent, preferred shareholders are entitled to a share of the company's assets after bondholders and other creditors are paid and before common shareholders get any payments. If a taxable Canadian corporation issues the preferred shares, you receive a special tax break on the dividends. Fixed-income investments like bonds pay interest that's taxed at your full tax rate. There is a wide range of preferred shares available. Typically, though, preferred shares have these characteristics: The dividend payment is fixed in advance. If a company has financial problems, the terms of the preferred share issue generally state that dividends can be postponed, but retroactive payments must be made when - and if - the company's finances improve. Preferred shares normally don't have any voting rights unless the company is in arrears on a stated number of dividend payments. Most preferreds have a redemption or 'par' value - this is the price that a company will pay for each share if it buys the issue back at a future date. Dividends on straight preferreds are a fixed amount, though some preferreds have floating rate dividends that are adjusted, depending on the movement in general interest rates. If interest rates are rising, your variable rate preferred's dividend payment would go up; if rates are falling, the dividend would likewise be reduced. Most straight preferreds are considered to be part of a company's permanent equity. This means these shares don't have a redemption date - the company has no obligation to buy them back on a fixed date. Typically, preferred shares are callable. The company can buy them back or redeem them at any time. The price you'd be paid would be set out in the terms of the issue. If you hold a preferred share that's retractable, you can force the company to buy the stock back from you. The terms of the buyback would be stated in the terms of the issue. Generally, it would be at a set price and it could only occur on or after a specific future date. Convertible preferred shares give you the option of exchanging these shares into the company's common shares at a set price, known as the conversion price, for a specified period of time. This may be an attractive feature if you believe the common share price will rise to the point where you would earn a profit by converting. However, the dividend on these shares will typically be less than on a straight preferred. You might be better off simply buying the common shares. Your convertible preferred share's market price will be influenced by the price of the common stock. If the common share price is above the conversion price, the preferred's price will tend to act like the common stock. Conversely, if the common share price is below the conversion price, the convertible preferred's price will tend to behave like a straight preferred: the potential to convert it into the common at a profit would be diminished. Straight preferreds, on the other hand, are influenced mainly by general interest rate levels. A rise in interest rates will likely cause the straight preferred share's value to fall. A fall in interest rates will probably cause the share's value to rise. Here are some pointers to keep in mind when buying straight preferred shares: Determine whether this preferred have a long history of paying its dividends? Consider the amount of risk you're assuming. Some preferreds may offer a higher rate of return. You should ask why. Maybe the preferred has been issued by a company with a poor credit rating. In this case, both your dividends and your principal could be at risk if the issuer runs into major financial problems. Find out if the preferred share is callable before maturity. If it is, and interest rates have dropped, it will likely be called because the company could then borrow money at lower rates. Of course, the time that a preferred might be called is precisely when you would want to keep it. See if the promised dividends are cumulative or non-cumulative. If they're cumulative, and most are, any unpaid dividends are not forgotten. They must be paid in full before common shareholders get any dividends and before the preferreds can be redeemed. If dividends in arrears are paid, they go only to people who still own the shares. Consider seeking professional investment advice. An investment or strategy that's appropriate for one investor may not suit your needs.