How do I buy preferred shares

Preferred shares: when do you get voting rights?

A preferred share is often seen as the counterpart to the common share. While shareholders with ordinary shares usually not only acquire shares in a company, but also receive a vote at the shareholders' meeting, there is only a higher dividend for preference shares.

What are preferred stocks?

The special thing about a preference share is that the security contains company shares, but has no right of co-determination. Like ordinary shares, preference shares are also issued in the event of a capital increase in a stock corporation and are traded on the stock exchange. The prices of preference shares can be found on the respective stock exchange. Stock market information services also provide information on the price development of preferred shares.

According to Section 139 of the German Stock Corporation Act, preference shares may represent a maximum of 50 percent of the share capital of a stock corporation. This is to ensure that at least half of the shareholders have a say.

Convertible and conventional preferred stock

A convertible preferred share is a share that can be converted into a common share at an agreed time. Convertible preference shares are issued by companies, for example, in order to create a special incentive for the purchase of shares, which at the same time brings fresh capital, but does not grant any participation rights for the time being.

Convertible preference shares can usually be exchanged by paying out the liquidation proceeds or by converting them into ordinary shares. If preference shares are exchanged for common shares, this usually corresponds to an indirect increase in the share capital.

Cumulative Preferred Stock

A cumulative preferred stock has all of the characteristics of traditional preferred stock. It also includes the right to a dividend claim, even if a company makes losses or the company profits are not sufficient to fully satisfy the guaranteed dividend payment.

In this case, the stock corporation is obliged to pay out the dividend in the following years to the holder of the cumulative preference share, if the profit allows it. If the profits are not sufficient to fully redeem the dividend entitlement in the following year, the preference share without voting rights must be converted into an ordinary share with voting rights.

The conversion will apply until the guaranteed dividend payments are balanced. The basis for this is provided by Paragraph 140 of the Stock Corporation Act. According to the German Stock Corporation Act, preference shares are always cumulative if the guaranteed dividends have not been paid by a company.

advantages

The advantage of the cumulative preference share is that the shareholder retains his dividend entitlement even in years of loss and the stock corporation is obliged to make additional payments. The disadvantage of this version is that the preference shares are converted into ordinary shares until the entitlement is satisfied. However, if the company's share price does not perform better, shareholders will lose money despite the cumulative preferred stock.

Other variants

The preferred share in Germany is subject to relatively strict regulations. In other countries there are other variants of the preferred share:

  • Limited preference shares: With this form, the preferred dividend is fixed at a certain amount. If the profit is higher, it will only be distributed among the ordinary shareholders. Shareholders with preferred shares have no further entitlement to a dividend payment.
  • Shares with an advance dividend: In this case, the shareholders of preferred shares receive a fixed dividend rate in advance in the form of a payout. Then the dividend is paid out. If there is still a remainder of the company's profit, this capital is distributed equally to all shareholders.
  • Shares with excess dividends: For this type of preferred share, it is stipulated that the dividend is generally higher than for shareholders of ordinary shares.
  • Preferred shares with multiple voting rights: Preferred shares do not always have to do without voting rights. In other countries it is possible, for example, that the preference for preference shares is a special voting right or even multiple voting rights. In Germany, however, such preference shares are not permitted under the Stock Corporation Act.

Preferred Stock and Common Stock

Ordinary shares and preferred shares are equally interesting for private investors. Both forms of shares offer both advantages and disadvantages. In general, preference shares differ from ordinary shares in that, as a shareholder with ordinary shares, you receive voting rights at the general meeting. In return, shareholders with preferred shares have no voting rights, but receive a higher dividend.

Theoretically, both stocks must be worth the same, since they make up the equity of a stock corporation in equal parts.

However, if no dividend can be paid and preference is not given to the preference shareholders, Section 140 of the German Stock Corporation Act applies and the preference shares must be converted into ordinary shares.

For shareholders, this means that they then receive voting rights and can vote at the general meeting. At the same time, there is a greater chance that the shares will rise in price in the event of an imminent takeover, as the acquiring company wants to secure as many voting rights as possible.

Conversion of preference shares into common shares

In the wake of the emissions scandal, the VW group had to set aside billions of dollars. As a result, no dividend was paid to shareholders in 2015. This means that shareholders with preferred shares have the right to have the dividend settled in the following year. If there is no compensation, the German Stock Corporation Act provides that preference shares are converted into ordinary shares. In 2017, all preference shares could then become ordinary shares.

That happens with a stock split

If a company decides to split its shares, preference and common shares are split evenly. All shareholders must participate equally in a share split so that nobody is disadvantaged. The ratio in which the shares are split is determined by the ratio of ordinary to preference shares.

Merger of common and preferred shares

Stock corporations can resolve at the general meeting that preference shares become ordinary shares, thus merging both classes of shares. The Fresenius Group, for example, carried out such a merger in 2010.

The aim of a merger for companies may be to issue securities that are easier to trade and to make them more attractive to investors. At the same time, the companies with a higher proportion of common shares are not so strongly bound to the payment of a certain amount of dividends and the capital is available more flexibly.

With a share merger, companies can also prepare for inclusion in a share index or for a takeover.

A merger can also be beneficial for shareholders. Not only do they receive voting rights with ordinary shares, but they can also benefit to a greater extent from the company's growth through rising share prices.

opportunities

Compared to other classes of shares, preferred shares can bring advantages for both companies and shareholders.

For shareholders

  • distribution: By waiving voting rights, shareholders receive a higher profit distribution in the form of a higher dividend. If it is a cumulative preference share, dividend payment is guaranteed even if the company makes losses.
  • More safety: With preference shares, investors are less tied to price developments. They are also preferred in the event of the company's liquidation.

For companies

  • family business: These companies can benefit from the issuance of preference shares, as there is no shift in the majority position despite the capital increase.
  • Protection against takeover attempts: Since preference shares are issued without voting rights, these shares are less attractive to other companies if they are acquired.
  • Financing option when the share price is low: Preferred stocks can be used as an incentive for investors when the company's stock market price is low. To compensate, the shareholders receive a higher share of the profits through the dividend.

Risks

The big disadvantage of preferred stocks is that if the company makes unexpectedly high profits, investors will not benefit. Because the dividend payment is fixed in advance and not dependent on profit.

However, the risk of investing in preferred stocks is significantly lower than with common stocks. In this way, losses are offset by the guaranteed dividend payment. Even when a stock corporation is liquidated, preference will be given to shareholders with preference shares over ordinary shareholders.

Nevertheless, as with all shares, preference shares can also be subject to a total loss. Such a loss can arise, for example, if preference shares must be converted into common shares and the company subsequently becomes insolvent.

Buy preference shares

As an investor, you can buy preference shares directly on the respective stock exchange. The purchase is usually made through your deposit that you have at a selected bank. There are numerous portals on the Internet that show which companies offer preference shares. Your custodian bank also has information on companies that issue preference shares.

When buying preferred stock, the price is usually a little below the common stock. Investors should pay attention to the rights that the preferred share grants. This can be, for example, the right to subsequent subscription, which includes the right to subsequent payment of the dividend in the event of default. In addition, investors should consider the amount of guaranteed dividend payment.