How to make preference shares work for youSunday, September 19, 2021
BY DAVID ROSE
New investors always tend to hear about ordinary and preference shares when they're first introduced to the stock market. Although most invest in ordinary shares and make gains, some people prefer to find options which suit their risk profile. In today's financial literacy article, we'll explain what preference shares are and how you can make money work for you.
Preference shares as they are termed carry greater weight than ordinary shares since they're preferred. On the capital structure of a company, preference shares rank just above ordinary shares which are last to be paid out in the event a company is wound up. However, like with anything in life, risk is matched with reward.
Debt holders are guaranteed fixed earnings and get paid out first while owners get paid last but have the benefit of unlimited upside potential. Preference shares usually have non-voting rights at the annual general meeting (AGM) of a company but their dividends are guaranteed before ordinary shareholders. Most of the preference shares on the market have a defined lifespan (tenure) with dividend payments being monthly, quarterly or semi-annually. Companies usually issue preference shares to execute some great corporate objective and tend to pay out the principal or amount borrowed amount at redemption date. Also, most preference shares are tax deductible for companies which means there is no withholding tax for the owners.
Let's look at the JMMB Group Limited (JMMBGL) preference shares issued in March at 7.15 and 7.35 per cent. JMMBGL issued 3.32 billion cumulatively redeemable preference shares at $3 for $9.97 billion. These shares were issued for seven years at fixed interest rates. This basically means that the rate is fixed relative to the principal and will be redeemed at the par value. JMMBGL's issued preference shares pay dividends monthly and are cumulative which means that if there's no payment, it will be eventually paid up later. This investment works for someone who is risk averse and is comfortable holding an investment which is of a debt nature.
Let's look at how investors can make money and capitalise on the preference share price on the market. So, let's say you buy 100,000 shares of the 7.15 per cent shares at $2 six months before redemption. When the shares are redeemed, you'd get $300,000 which would not include the dividends payable on those shares. This is a 50 per cent increase in principal over a short time frame relative to what was invested initially. So, instead of holding from day 1 when it was issued, a person can just buy the shares closer to redemption and benefit from the return on principal compared to the interest rate of 7.15 per cent.
Though this is the easiest way to make money on preference shares, some people also make mistakes and purchase well above par without understanding the time remaining on the preference share or the interest rate being fixed or variable. Back in July, someone purchased 13,273 shares of a preference share at $17.04 which is $226,171.92. However, the preference share has a par value of $6 and is redeemable at the end of 2024. So, when redeemed, the person would get back $79,638 in principal which is a 71 per cent loss before factoring in the fixed interest rate dividend payments.
Preference shares also open the opportunity for people to get exposure to companies whose ordinary shares are not listed on stock exchanges. One classic example of this is with the Jamaica Public Service Limited (JPS) preference shares. JPS only has three ordinary owners but has numerous preference shareholders. JPS pays dividends on these preference shares quarterly at fixed rates. At the moment, the JPS Class F preference shares (9.5 per cent) are being sold on the market at $1,700. This preference share is non-redeemable and has returned more than 40 per cent in capital to owners through these preference share dividends. They recently declared a dividend of US $0.23945205478 per share which is US $588,000.25 to be paid on September 22. JPS paid US $2.34 million on its preference shares in 2020 relative to US $10 million paid on its ordinary shares.
Most preference shares on the Jamaica Stock Exchange are redeemable and tend to be variable rate after a moratorium period. The variable rate is usually a fixed rate such as three per cent plus the Bank of Jamaica's (BOJ) 180-day weighted average treasury bill yield. This yield has come down over the years which has saved companies money in lower preference share dividend costs. The BOJ's most recent auction saw the yield at 1.94 per cent compared to 1.20 per cent in July. Thus, when the rate is reset for companies going forward, people who get variable rate preference shares might get more in dividend income on these financial securities.