Should You Prefer A Preferred Stock?

Should You Prefer A Preferred Stock?

A company has two kinds of stocks, namely Common stock and Preferred stock. Preferred stockholders enjoy privilege over common stockholders with respect to payment of dividends, generally paid either monthly or quarterly with a higher yield than the common stock. Preferred stocks are good for investors who aim to achieve stability in potential future cash flows due to the payment of fixed dividends and their potential to uplift the share price.

Common Stock in Detail

Common stock, as the name suggests, is the most common form of security that most people invest in. Majority of the company’s stock is issued in this form, with the value of the stock going up when the business flourishes and deteriorate when the business does not perform well. Common stock provides could yield great potential for both short-term and long-term gains. When it comes to the rights of common stockholders, they enjoy voting rights in the company, which is generally in the form of one vote per share.

Common stockholders are the last in line when the company distributes its income or earnings and may even go without earning a dividend when the company’s earnings fall short after the payment of dividend/interest on preferred shares/bondholders. The company first pays out to the creditors, bondholders or preferred shareholders and distributes the remainder amongst common stockholders.

Preferred Stock in Detail

Preferred shares are considered as hybrid security due to a blend of features, similar to both debt and equity. Some of the similarities between preferred stock and a bond lie in the payment of fixed dividends, response to changes in the interest rates and the option to redeem or repurchase after a specified point of time.

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Preferred stocks are generally issued in four categories as mentioned below:

  • Cumulative preferred stock – This category involves payment of dividends, including those omitted in the past, before the common stockholders.
  • Non-Cumulative preferred stock – Under this category, the shareholders cannot claim omitted dividends during any given year.
  • Participating preferred stock – This category entitles the shareholders to an additional dividend along with the amount equal to generally specified rate of dividend.
  • Convertible preferred stock – Under this category, shareholders can convert preference shares into common shares, any time after a specified time.

Advantages: Preferred shareholders are entitled to a fixed dividend paid before any payment to common stockholders. Some preferred shares also give an option to accumulate unpaid dividends when a company does not earn enough profits and are paid when the business turns profitable. Another advantage that preferred shares offer is in terms of the right to claim the company’s assets. Preferred shares have a larger share in the company’s assets than common shareholders at times of bankruptcy and liquidation. The lack of voting rights to preferred shareholders also comes as an advantage, as there is no dilution of ownership when they are sold.

Risks Associated: Apart from the advantages that preferred stocks offer in terms of priority during dividend payments, there are certain risks that should be taken into consideration as well. Preferred stock is sensitive to interest rates, which impacts the share prices. Another risk is the call risk that comes with the option to redeem the shares on demand before maturity. Preferred stocks are often rated well by rating agencies.

How is Preferred Stock Different from Common Stock?

While both Preferred stocks and Common stocks are similar when it comes to the ownership rights in the company and the profits generated by the company from future business growth, there are certain important features that set aside a preferred stock from a common stock.

  • Voting rights – Under Preferred stock, the shareholders do not have any voting rights unlike common stock that usually enjoy one vote for one share. Therefore, preferred stockholders do not participate in key decision-making, including the election of a Director on Board or voting for any kind of corporate policy.
  • Dividend Yield – When it comes to dividend yield, common stockholders may receive varying amounts of dividends over different periods as declared or announced by the Board of Directors. Hence, the dividends on common stocks are never guaranteed. In case of preferred stock, the dividend amount is based on the par value of the share when preferred stock is offered and the preferred stockholders are entitled to a dividend when the company meets the conditions set at the time of issuing the preferred shares.
  • Rights on Liquidation – In case of liquidation, preferred stockholders have priority over common stockholders when claiming the company’s assets and earnings. In addition, preferred stockholders are considered before common stockholders, when it comes to the distribution of dividend through excess cash available during the company’s good phase.
  • Redemption of shares – Unlike common stockholders, preferred stockholders have the rights to redeem the shares after a specified point of time and can call back the shares at a redemption rate with a significant premium over the purchase price of the share.

On ASX the common stocks have 3 letter codes, and the preferred stocks have 5 letter codes with the company code and a two-letter suffix either PA or PZ.

BHP Group Limited (ASX: BHP)

BHP Group Limited (ASX: BHP) is engaged in the mining activities along with the exploration, development and production of oil and gas. The company recently updated that one of the Directors, Ian Cockerill, acquired 3,500 ordinary shares for a consideration of GBP 19.25 per share.

In a recent update for the nine months ended 31st March 2019, the company reported a strong operational performance during the period, despite weather impacts across Australia and Chile. Total petroleum production during the period was 92 MMboe, copper production was 1,245 MMboe and iron ore was 175 MMboe.

Production Data (Source: Company Reports)

During the six months ended 31st December 2018, the company generated an attributable profit of US$3.8 billion as compared to US$2.0 billion in the prior corresponding period. Underlying attributable profit amounted to US$3.7 billion against the prior period value of US$4.1 billion. Underlying EBITDA during the period stood at US$10.5 billion as compared to US$10.8 billion in the prior period. The period was characterised by a strong balance sheet and fully funded capital investment plans.

1HFY19 Results (Source: Company Presentation)

For the year ended 30th June 2018, the company declared a 5.5% dividend on 50,000 preference shares of EUR 1 each to be paid annually. As per the annual report, the preferred shareholders are entitled to a dividend in priority to any payment of dividend on any other class of shares. The company has provided preferred shareholders with a right of conversion to ordinary shares. As per the terms, it also allows itself or the shareholder to redeem the preferred shares.

The stock of the company at market close was trading at a price of $41.850, down 0.547%, with a market cap of $123.96 billion on 04 July 2019.


Disclaimer

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