What Is Zero-Dividend Preferred Stock?
A zero-dividend preferred stockis a preferred share issued by a company that is not required to pay a dividend to its holder. The owner of a zero-dividend preferred share will earn income from capital appreciation and may receive a one-time payment at the end of the investment term.
Key Takeaways
- Zero-dividend preferred stock is preferred stock that does not pay out a dividend.
- Common stock is still subordinate to zero-dividend preferred stock.
- Zero-dividend preferred stock earns income from capital appreciation and may offer a one-time lump sum payment at the end of the investment term.
- Issuers benefit from zero-dividend preferred stock as it allows them to raise capital, holds no voting rights, and pays no dividend.
- There are a few advantages and disadvantages of zero-dividend preferred stock for investors.
Understanding Zero-Dividend Preferred Stock
When a company issues stock, they issue two types: preferred stock and common stock. Preferred stock has priority over common stock when it comes to dividends and asset distribution and is therefore seen as less risky. Preferred stock usually does not have voting rights, whereas common stock does.
Owners of zero-dividend preference shares will not receive a normal dividend but they will still maintain reimbursem*nt priority over common shareholders in the event of a bankruptcy. In such an event, they will get a fixed sum that was agreed upon in advance.
Zero-dividend preferred stock is comparable in some ways to zero-coupon bonds, though they are regarded as lower tier than bonds. Still, they do have upper-tier preference compared with common shareholders if a bankruptcy occurs. This type of stock is usually backed by the issuer’s assets and can be part of split capital investment trusts as a sort of share to produce fixed capital growth in a defined period.
Why Zero-Dividend Preferred Stock Is Issued
Companies that are likely to issue zero-dividend preferred stock include investment trusts, particularly those that may face challenges getting long-term debt approved. Zero-dividend preferred stock usually comes with a specific time period.
Issuing zero-dividend preferred stock is a way for an investment trust to raise capital that is easier than seeking a loan from a bank, and oftentimes lasts much longer than a bank would typically be willing to lend for. Zero-dividend preferred stock also comes with fewer restrictions than a bank would include in a loan. A zero-dividend preferred stock raises capital, holds no voting rights, and doesn't pay out a dividend. It's an extremely attractive option for a company to issue.
Advantages and Disadvantages of Zero-Dividend Preferred Stock
There are many advantages and disadvantages for an investor that come with a zero-dividend preferred stock.
Disadvantages
- Zero-dividend preferred stocks are vulnerable to increasing inflation, just as bonds are.
- The fluctuations of the market could see this type of stock be outperformed if the market rises.
- There is also no guarantee on its yields and the underlying assets could erode in value if the market goes through a downturn.
Advantages:
- The lack of taxes that would normally be warranted on dividends. Also, the lump sum payout would be taxed as a capital gain as opposed to net income, which would be at a lower rate.
- There is an expectation of a predetermined return within the window of time set for the stock.
- These shares are also predominantly less volatile when compared with equities.
FAQs
Zero-dividend preferred stock earns income from capital appreciation and may offer a one-time lump sum payment at the end of the investment term. Issuers benefit from zero-dividend preferred stock as it allows them to raise capital, holds no voting rights, and pays no dividend.
What are the pros and cons of preferred stock? ›
Preferred stocks are usually less risky than common dividend stocks, and carry higher yields, but lack the opportunity for price appreciation as the issuing company grows. They also go without voting rights.
What is zero dividend? ›
Zero Dividend Policy is a dividend policy structure of a company in which it chooses to pay zero or nil dividend to its shareholders. This may be due to many reasons, may be company is having potential investment projects with positive NPV.
Are stocks without dividends worth it? ›
The assets and liabilities of a firm can be summed to give the book value, and stocks priced below book value frequently perform well. Stocks without dividends can be excellent investments if they have low P/E ratios, strong earnings growth, or sell for below book value.
What are the pros and cons of stock dividends? ›
The stock dividend has the advantage of rewarding shareholders without reducing the company's cash balance. However, it does increase its liabilities. Stock dividends have a tax advantage for the investor as well. Unlike cash dividends, stock dividends are not taxed until the investor sells the shares.
Is it safe to invest in preferred stock? ›
Preferred stock is a hybrid security that integrates features of both common stocks and bonds. Preferred stock is less risky than common stock, but more risky than bonds.
What can go wrong with preferred stock? ›
Share prices of preferred stocks often fall when interest rates move higher because of increased competition from interest-bearing securities that are deemed safer, like Treasury bonds. Call risk is also a consideration with some preferred stocks because companies can redeem shares when needed.
How do you make money on non-dividend stocks? ›
How do you make money from stocks that don't pay dividends? The two ways to profit from stock investing are capital gains and dividends. If dividends aren't an option with the stock, then your only profit potential is from capital gains.
Is it better to buy stocks with dividends or not? ›
Dividend investing can be a great investment strategy. Dividend stocks have historically outperformed the S&P 500 with less volatility. That's because dividend stocks provide two sources of return: regular income from dividend payments and capital appreciation of the stock price.
Why I don't invest in dividend stocks? ›
However, they typically offer lower returns than stocks. Dividend-paying stocks have the potential for income through dividends and capital appreciation, but they come with higher volatility and market risk. The choice between the two depends on your risk tolerance, investment goals, and time horizon.
However, not all dividend stocks are made equal, and you should avoid some of them altogether. Some companies prioritize high dividends to attract investors, but this can be a risky strategy. These “dividend traps” often cannot sustain payouts, leading to unexpected cuts and derailing your investing plans.
How to make 5k a month in dividends? ›
To generate $5,000 per month in dividends, you would need a portfolio value of approximately $1 million invested in stocks with an average dividend yield of 5%. For example, Johnson & Johnson stock currently yields 2.7% annually. $1 million invested would generate about $27,000 per year or $2,250 per month.
What are the advantages and disadvantages of preference shares? ›
Lack of voting rights: Preference shareholders do not have a say in the company's decisions, which can be a disadvantage if the company's management makes unfavourable choices. Market performance: The performance of preference stocks can be influenced by market conditions, and their value may fluctuate accordingly.
Why would you want preferred stock? ›
Most shareholders are attracted to preferred stocks because they offer more consistent dividends than common shares and higher payments than bonds. However, these dividend payments can be deferred by the company if it falls into a period of tight cash flow or other financial hardship.
Why do companies not like preferred stock? ›
Preferred stock dividend payments are not tax deductible to the issuing corporation. This makes issuing preferred stocks much more expensive for a company than issuing bonds. Most companies with solid credit ratings don't issue preferred stocks.
