Preference Shares

Retail Equity Research

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PREFERENCESHARES

KnowledgeSeries

16 August, 2012
Companies issue shares to raise capital for business. They issue two types of shares- Equity shares and
Preference shares. Equity shares are ordinary shares which represent ownership in a company and carry
voting rights. They are entitled for distribution of income by way of dividends. On the other hand, Preference
shares have a fixed rate of dividend which is paid before payment of dividend to Equity shareholders.
Preference shareholders are given preference in payment of dividend and return of capital during winding up.
A comparison between various types of Preference Shares:
Participating Preference shareholders have the
right to participate in additional profits of the
company when Equity Shares are paid dividend
above a certain level.
Convertible Preference shares can be converted
into Equity shares if the Preference shareholder
desires so, subject to the terms of the issue.

Non-Participating Preference shareholders do

not have such rights.

Redeemable Preference shares are those shares

which have to be repaid by the company after a
fixed period of time from the date of issue of such
shares.

Irredeemable Preference shares are not

redeemed by the company except on winding up of
the company. These are perpetual.

Cumulative Preference shares give the right to

the Preference shareholders to receive arrears of
dividends which are not paid in the previous years
due to insufficiency of profits.

Non-cumulative Preference shareholders do not

have the right like Cumulative Preference
shareholders and therefore cannot demand any
arrears of past years unpaid dividend.

Non-Convertible Preference shares are

allowed to be converted to Equity shares.

not

Attributes of Cumulative Redeemable Non-Convertible Preference share:

1. The dividend will get accumulated over the years in case the dividend is not paid by the company in a
particular year because of non availability of profits.
2. Dividends from Indian companies are tax free in the hands of the shareholders as companies pay
Corporate Dividend Tax.
3. Preference shares may be redeemed after the expiry of a certain period of time which is indicated by
the company.
If the Preference shares are given Convertible status by the Company:
In that case the company may give the Preference shareholders an option to convert the Preference
shares into Equity shares at a future date.
If the Preference shares are given Participating status by the Company:
In that case the Preference shareholders have the right to participate in additional profits of the
company when Equity shareholders are paid dividend above a certain level.

Preference Shares
There are other instruments in the market that have higher interest rates like NCDs or Tax free Bonds and
may seem attractive investment destinations but a closer scrutiny reveals the following comparison:
Illustration: Comparison of Preference shares with NCDs (for 1 yr)

Particulars
TaxSlab
Investment(Rs)
DividendRate(Assumed)
InterestRate(Assumed)
Dividend/Interest(Rs)
TaxPayablebyinvestor
PostTaxReturn(Rs)
NetGainRate

PreferenceShares

1,00,000
8.35%pa*

8,350

8,350
8.35%

30.9%
1,00,000

10%pa
10,000
3,090
6,010
6.01%

NCDs
20.6%
1,00,000

10%pa
10,000
2,060
7,940
7.94%

10.3%
1,00,000

10%pa
10,000
1,030
8,970
8.97%

*Net Dividend payable to investors post Dividend Distribution Tax

The Preference Shares mainly caters to HNIs and salaried individuals falling in the 30% tax
bracket. The illustration below shows returns from Preference Shares as equivalent pre-tax
interest on NCD.
Illustration: Returns from Preference Shares as equivalent pre-tax interest on NCD

DividendfromPreferenceShare
8.35%pa
8.35%pa
8.35%pa

ITSlabRate
30.9%
20.6%
10.3%

EquivalentinterestrateonNCD
12.08%pa
10.52%pa
9.31%pa

Preference shares v/s Tax free bonds

1. Redeemable Preference shares have a lesser tenure than tax free bonds which normally have a
tenure exceeding 10 years.
2. Tax-free bonds which are traded on the exchange are often illiquid for bulk transactions and
investors may find it difficult to sell them on the exchange vis--vis Redeemable Preference shares
which can be redeemed by issuing company.
3. Cumulative nature of the Preference shares is an advantage over tax free bonds and at the same
time Participating Preference Shares may yield even better returns.
4. If the Tax Free Bonds are listed, their prices would appreciate on account of interest rate cuts in a
declining interest rate scenario which may cause a fall in their yield. However, similar price
fluctuations may also be witnessed in prices and yields of Preference shares if they are listed.
Summary
Preference Shares is a well suited investment avenue for HNIs and Individuals who fall in the 30% tax bracket
to earn tax free returns year on year with an option to convert into Equity shares. An added advantage is that
Listed Preference Shares can also be used to avail loan facility by using them as collateral. Sometimes
Preference Shareholders are also given preferential allotment in public issue of Equity Shares which is subject
to rules & regulations.
Investors can call Tata Securities Customer Care at 1800-209-9111 for any queries or
information relating to ongoing issues.
Happy Investing!!!

Preference Shares

Tata Securities Limited

One Forbes, Dr V.B. Gandhi Marg, Fort, Mumbai 400 001
Tel: 91 22 6745 9000 Fax: 91 22 6610 6722
Web: www.tatasecurities.com
SEBI Registration Number BSE INB010664150 INF011207954 NSE INB/F/E231288730 Portfolio Manager INP000003872
Depository Participant of CDSL: IN-DP-CDSL-450-2008 Depository Participant of NSDL: IN-DP-NSDL-298-2008 Merchant Banker INM 000011302
Compliance Officer: Mr. Umesh Maskeri : 022 - 61827805 email:umesh.maskeri@tatacapital.com
Head- Retail Research: Sanjit Sen, B.Com (Hons), A.C.A Email id: Sanjit.Sen@tatacapital.com

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1. Name of the analyst

: Vasu Goyal

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: B.Com (Hons), A.C.A, C.S

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related to the information contained

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