What is Zero Dividend Preferred Stock?

Last Updated: 6 Aug 2024

Preference shares, often known as preferred stock, pay dividends to owners as a priority over ordinary or common stock payments. If a company files for bankruptcy, the preferred shareholders are paid first, followed by the common shareholders. preference shares frequently pay a fixed dividend, while regular stocks do not. However, preferred investors do not have voting rights, which ordinary stockholders do.

Several investors buy a preferred stock because it provides them with an array of benefits. One option to the traditional type of preferred stock is called a zero dividend preferred stock. This article covers the meaning of zero dividend preferred shares and what it provides to you, as an investor.

What are zero dividend preference shares?

Zero dividend preference shares definition is simple — it is a preferred share issued by a company that does not require payment of dividend to those shareholders. The owners of zero dividend preferred shares earn their income from capital appreciation. Additionally, in some cases, zero dividend preferred stockholders may get a one-time payment when they cash out at the end of their investment term. Zero dividend preference shares are also often referred to as ‘capital shares’.

When a company issues shares, the shares are commonly of two types of shares:

• Preferred stock
• Common stock

Preferred stock is considered low-risk because it takes precedence over Common stock in terms of dividend and capital allocation.

In the case of zero dividend preferred shares, shareholders do not receive regular dividends but retain repayment priority over common shareholders in the contingent event of bankruptcy. In situations like this, they will receive a fixed sum that was agreed upon much in advance. However, the company first repays any loans they owe. Hence, returns still rely largely on the performance of the trust’s investments and the capital risk remains.

As an investor, you look for all your gains from capital appreciation, i.e. in the price of the stock itself. Therefore, this type of stock may not be attractive to those that seek a regular income that a stock paying dividend can provide.

Zero dividend preferred shares are comparable to zero-coupon bonds in some ways; although they are considered lower tier than bonds. Nevertheless, in the event of bankruptcy, zero dividend preferred shares will take precedence over ordinary shares. This type of stock is usually backed by the issuer’s assets and may be part of co-investment funds as a sort of share to create fixed capital growth over a defined period.

Before investing in a zero dividend preferred stock, you should consider its many advantages and disadvantages.

Advantages of a zero dividend preferred stock

• There is no tax on dividends. Also, the lump-sum payouts at the end of the term are taxed as capital gains rather than net income, which again, warrants being taxed at a lower tax rate.
• A given rate of return is expected within the period of holding.
• Zero dividend preferred shares tend to be less volatile when compared to equity.

Disadvantages of a zero dividend preferred stock

• The zero dividend preferred stock, much like bonds, is very vulnerable to rising inflation.
• Market volatility can cause this type of stock to outperform when the market rises.
• Stocks are never a guaranteed play. Similarly, for a zero dividend preferred stock, there is no guarantee of its yields. The underlying assets may even decrease in value if the market goes through a downturn.

Why are zero dividend preferred stocks issued?

Generally, companies likely to issue zero-dividend favoured inventory include investment funds or trusts, in particular the ones that could face challenges in getting long-term debt approval. A zero dividend preferred stock has a selected period.

Issuing zero dividend preferred shares is a way in which investment trusts raise capital that is potentially easier than seeking a loan from a bank. Often, it also lasts a great deal longer than a bank would normally be inclined to lend for.

Additionally, they come with fewer regulations compared to a bank’s regulations for the same loan. A zero dividend preferred stock increases capital holds no vote casting rights and doesn’t pay out a dividend. They are considered an incredibly appealing alternative for a company to issue.

To summarize the meaning of zero dividend stock:

• A zero dividend preferred stock does not pay a dividend.
• Common stock remains subordinate to zero dividend preferred shares.
• A zero dividend preferred stock generates income through capital appreciation and may provide a one-time fixed sum payment at the end of the investment term.

Final Word

A zero dividend preferred stock benefits issuers since it allows businesses to raise more liquidity, has no voting rights, and pays no dividend. For investors, there are certain benefits and drawbacks to consider when it comes to investing in a zero dividend preferred stock.