Provided by Investing.com
In the world of investing, diversification is often hailed as a cornerstone of success. While spreading investments across various asset classes is crucial, there’s another strategy that seasoned investors swear by: incorporating high-quality dividend stocks into their portfolios.
But why are dividend stocks so revered, and how can they enhance your investment journey? Dividend-paying companies often exhibit stability and consistency in their earnings. By distributing a portion of their profits to shareholders,
These companies demonstrate financial health and a commitment to shareholder interests. This steady stream of income provides a cushion during volatile market conditions, offering investors a sense of security….Continue reading…
By: Aayush Khanna
Source: The Power of Dividend Investing and How to Create Such a Portfolio | Investing.com
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Critics:
Preferred stocks offer a company an alternative form of financing—for example through pension-led funding; in some cases, a company can defer dividends by going into arrears with a little penalty or risk to its credit rating, however, such action could hurt the company meeting the terms of its financing contract. With traditional debt, payments are required; a missed payment would put the company in default.
Occasionally, companies use preferred shares as a means of preventing hostile takeovers, creating preferred shares with a poison pill (or forced-exchange or conversion features) that is exercised upon a change in control. Some corporations contain provisions in their charters authorizing the issuance of preferred stock whose terms and conditions may be determined by the board of directors when issued.
These “blank checks” are often used as a takeover defence; they may be assigned very high liquidation value (which must be redeemed in the event of a change of control), or may have great super-voting powers. When a corporation goes bankrupt, there may be enough money to repay holders of preferred issues known as “senior” but not enough money for “junior” issues.
Therefore, when preferred shares are first issued, their governing document may contain protective provisions preventing the issuance of new preferred shares with a senior claim. Individual series of preferred shares may have a senior, pari-passu (equal), or junior relationship with other series issued by the same corporation.
Preferred shares are more common in private or pre-public companies, where it is useful to distinguish between the control of and the economic interest in the company. Government regulations and the rules of stock exchanges may either encourage or discourage the issuance of publicly traded preferred shares. In many countries, banks are encouraged to issue preferred stock as a source of Tier 1 capital.
A company may issue several classes of preferred stock. A company raising venture capital or other funding may undergo several rounds of financing, with each round receiving separate rights and having a separate class of preferred stock. Such a company might have “Series A Preferred”, “Series B Preferred”, “Series C Preferred”, and corresponding shares of common stock.
Typically, company founders and employees receive common stock, while venture capital investors receive preferred shares, often with a liquidation preference. The preferred shares are typically converted to common shares with the completion of an initial public offering or acquisition. An additional advantage of issuing preferred shares to investors but common shares to employees is the ability to retain a lower 409(a) valuation for common shares and thus a lower strike price for incentive stock options. This allows employees to receive more gains on their stock.
In the United States there are two types of preferred stocks: straight preferreds and convertible preferreds. Straight preferreds are issued in perpetuity (although some are subject to call by the issuer, under certain conditions) and pay a stipulated dividend rate to the holder. Convertible preferreds—in addition to the foregoing features of a straight preferred—contain a provision by which the holder may convert the preferred into the common stock of the company.
(Sometimes, into the common stock of an affiliated company) under certain conditions (among which may be the specification of a future date when conversion may begin, a certain number of common shares per preferred share, or a certain price per share for the common stock).There are income-tax advantages generally available to corporations investing in preferred stocks in the United States. See Dividends received deduction.
But for individuals, a straight preferred stock, a hybrid between a bond and a stock, bears some disadvantages of each type of securities without enjoying the advantages of either. Like a bond, a straight preferred does not participate in future earnings and dividend growth of the company, or growth in the price of the common stock. However, a bond has greater security than the preferred and has a maturity date at which the principal is to be repaid.
Like the common, the preferred has less security protection than the bond. However, the potential increase in the market price of the common (and its dividends, paid from future growth of the company) is lacking for the preferred. One advantage of the preferred to its issuer is that the preferred receives better equity credit at rating agencies than straight debt (since it is usually perpetual).
Also, certain types of preferred stock qualify as Tier 1 capital; this allows financial institutions to satisfy regulatory requirements without diluting common shareholders. Through preferred stock, financial institutions are able to gain leverage while receiving Tier 1 equity credit. If an investor paid par ($100) today for a typical straight preferred, such an investment would give a current yield of just over six percent.
If, in a few years, 10-year Treasuries were to yield more than 13 percent to maturity (as they did in 1981) these preferreds would yield at least 13 percent; since the rate of dividend is fixed, this would reduce their market price to $46, a 54-percent loss.The difference between straight preferreds and Treasuries (or any investment-grade Federal-agency or corporate bond) is that the bonds would move up to par as their maturity date approaches; however, the straight preferred (having no maturity date) might remain at these $40 levels (or lower) for a long time.
Advantages of straight preferreds may include higher yields and—in the U.S. at least—tax advantages; they yield about 2 percent more than 10-year Treasuries, rank ahead of common stock in case of bankruptcy and dividends are taxable at a maximum rate of 15% rather than at ordinary-income rates (as with bond interest).
Advantages of preference shares:
No obligation for dividends: A company is not bound to pay a dividend on preference shares if its profits in a particular year are insufficient. It can postpone the dividend in case of cumulative preference shares also. No fixed burden is created on its finances. No interference: Generally, preference shares do not carry voting rights. Therefore, a company can raise capital without dilution of control. Equity shareholders retain exclusive control over the company.
Trading on equity: The rate of dividend on preference shares is fixed. Therefore, with the rise in its earnings, the company can provide the benefits of trading on equity to the equity shareholders. No charge on assets: Preference shares do not create any mortgage or charge on the assets of the company. The company can keep its fixed assets free for raising loans in future.
Variety: Different types of preference shares can be issued depending on the needs of investors. Participating preference shares or convertible preference shares may be issued to attract bold and enterprising investors.
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