What Is Zero-Dividend Preferred Stock?

A zero-dividend preferred stock is 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.
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What Is A Dividend?

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 reimbursement 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.