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SA Preference Shares

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Preference Shares are capital stock, which provides a specific dividend. Holders of preference shares have a prior right over all holders of ordinary shares to the distribution of dividends and repayment of capital on winding up. Preference shares normally offer a fixed annual rate of dividend, but recently also a variable rate or a combination of fixed and variable rates. The company is liable for any arrears in respect of preference dividends, unless specifically defined as non-cumulative. Because the dividend payout is usually fixed, the dividend is more regular and stable than that of ordinary shares. Preference shares normally have no voting rights. In general, there are four different types of preference shares; cumulative preference shares, non-cumulative, participating, and convertible.

A cumulative preference share means any dividends that have been missed will accrue. This means that a company that is unable to pay dividends for a specific period will still be liable for those missed dividend payments once the company is in a position to resume the dividend payments. The preference shareholder is still entitled to those dividends.

Non-cumulative preference shares do no entitle holders to any missed dividends. As the name suggests, the missed dividends do not accumulate, and the company is not liable to pay any of those missed dividends.

Participating preference shares allow the holder to receive a higher dividend than was initially set if the company performs well. Therefore holders have a bottom limit as to their dividend payments, but are not constrained on the up side.

The fourth type - convertible preference shares, allow the holders to convert these shares into a predetermined amount of ordinary shares.

Who should invest in Preference Shares

Investing in preference shares is an attractive option for affluent clients who are usually more tax-sensitive.

Taxability

Preference Shares dividends are not taxable under current legislation. There can be a Capital Gains Tax liability.

Dividend Yield

Currently dividend yields on preference shares range from 2.92% to 9.64%.

The lowest yielding preference shares (also the highest credit rated) tend to be issued by the four big SA banks. Industrial companies have the highest yield and are typically also the lowest credit rated. It is important to check the credit rating and whether the dividends are cumulative or non-cumulative before buying preference shares. When a company defaults, preference shares rank behind debt but ahead of equity. In the event of default it is highly probable that an investor will not get their capital back. With bank preference shares, which are non-cumulative, a dividend can be skipped and be resumed again at a later stage. However skipping a preference share dividend may deter investors from buying shares at future preference share issues.

Preference shares issued by most other companies, such as the industrial companies are generally higher risk but their dividends are cumulative. Therefore these companies have to pay the dividend at some stage before ordinary shareholders can receive their dividends again.

Click to view the Latest Fund Fact Sheet:

Source : Sanlam Private Clients (SPI) 10/2015

Factors which influence Preference Shares

  • A change in the interest rate will influence the price of preference shares. Demand increases as shareholders move from interest bearing instruments to dividend income instruments for the tax benefit.
  • The dividend cycle, the share price will go up closer to the dividend date and will drop after the last day to trade, as the shareholder has to wait another six months for the dividend.
  • Demand for the share is influenced greatly by the tax efficiency of preference shares as well as the cycle of the share. Shareholders will move from one to the other if the one preference share is offering better value than the other.
  • Market sentiment and legislation may also affect the share price of preference shares but the main influencing factors of preference shares are interest rates and the dividend cycle.

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