When investing in the stock market actively, understanding the different types of dividends can significantly impact your financial decisions. One such type is the preferred dividend, which is tied to preferred shares, a class of ownership in a company. In this blog, you will get to know the meaning of preferred dividends and how they differ from common stock dividends, as well as highlight their importance for investors using online trading platforms.
Preferred dividends are payments made to shareholders who own preferred stock in a company. These dividends have a fixed rate, meaning shareholders receive them at predetermined intervals, usually quarterly, regardless of the company's overall profit performance. While preferred shareholders do not typically have voting rights like common shareholders, their dividends are given priority. This means that preferred dividends are paid out before any dividends are distributed to common shareholders.
For example, if a company faces financial difficulties and can only pay some of its dividends, preferred shareholders will be paid first. This gives a certain level of security to preferred stockholders, making it a less risky investment compared to common shares. If you’re someone who has just started investing in the stock market, knowing more about these shares will help you in navigating your returns.
The functioning of preferred dividends is quite different from common stock dividends. The key aspect is the fixed dividend rate. A company that issues preferred shares commits to paying a specified dividend amount. For instance, if you hold preferred shares with a 5% dividend rate and the par value of the share is ₹1,000, you will receive ₹50 annually per share in dividends, regardless of the company's financial condition.
Additionally, preferred dividends may be cumulative or non-cumulative. Cumulative preferred dividends ensure that if the company skips dividend payments in one period, it must make up for the missed payments before distributing any dividends to common shareholders in the future. Non-cumulative preferred dividends, however, do not have this feature—missed dividends are not paid at a later date.
Preferred dividends offer benefits both for companies and investors. For companies, issuing preferred shares allows them to raise capital without giving up significant control or diluting voting power since preferred shareholders usually have limited or no voting rights. It also provides a stable and predictable obligation in the form of fixed dividend payments, which companies can plan for more easily than variable common stock dividends.
For investors, preferred dividends provide a steady income stream and rank higher than common dividends in terms of payment priority. Investors using an online trading platform can consider preferred shares when seeking a balance between lower risk and consistent returns.
Preferred dividends can come in various forms, each offering different benefits:
As mentioned earlier, cumulative dividends guarantee that unpaid dividends from prior periods must be paid before any common dividends. This feature is an advantage during challenging financial times for companies, ensuring shareholders are compensated for missed payments.
In contrast to cumulative dividends, non-cumulative preferred dividends do not require the company to pay missed dividends in the future. This type of dividend is less beneficial for investors but may still appeal to those who prefer a lower-risk investment.
Participating preferred dividends allow shareholders to receive additional dividend payments if the company performs exceptionally well. In addition to the fixed dividend, participating preferred shareholders may also receive a portion of the remaining profits after common shareholders are paid.
Convertible preferred dividends give shareholders the option to convert their preferred shares into normal shares at a predetermined conversion rate. This allows investors to potentially benefit from an increase in the company's common stock price while still enjoying the stability of preferred dividends.
Preferred dividends are generally considered ordinary income for tax purposes, so they may be subject to different tax rates depending on your country's regulations. In India, dividends received by shareholders are taxed based on their total income, with applicable rates depending on the income tax slab of the individual. Investors using online trading platforms should keep this in mind when deciding whether to include preferred shares in their portfolios.
Investing in preferred shares is relatively straightforward, especially with the help of an online trading platform in India. Many platforms offer access to all types of shares, including preferred stock. When choosing preferred shares, it is essential to consider the dividend rate, the company's financial health, and the type of preferred shares available.
Additionally, you may want to review a company's financial statements to understand its ability to sustain preferred dividend payments, especially during times of economic uncertainty. Preferred shares are more appealing to conservative investors looking for stable returns with relatively lower risk compared to common stocks.
While preferred dividends offer benefits like fixed income and payment priority, there are also associated risks. Unlike bonds, preferred shares do not have a maturity date, meaning your investment could remain tied up indefinitely. Furthermore, preferred shareholders do not have the same growth potential as common shareholders, as they typically do not participate in stock price appreciation.
Additionally, preferred dividends are not guaranteed—if the company goes bankrupt, preferred shareholders may still lose their investment, though they rank higher in the repayment order than common shareholders.
Preferred dividends provide a unique opportunity for investors seeking a steady income without the volatility often associated with common stocks. These dividends are an attractive option for those looking to diversify their portfolio and minimise risk, as they come with a predictable income stream and payment priority.
Investing in preferred shares through an online trading platform is also an efficient way to manage your portfolio. Many platforms provide the tools needed to analyse preferred shares, track dividend payments, and adjust your investment strategy based on market conditions.
Preferred dividends can be a useful addition to your investment portfolio, especially for those focused on consistent returns. However, their lower growth potential compared to common stocks may not suit every investor. When using a trading platform in India, carefully review your financial goals and risk tolerance before investing in preferred shares. Making informed decisions and choosing the best platform can maximise the benefits of preferred dividends while mitigating potential risks.
For android only