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DEFINITION of 'Zero-Dividend Preferred Stock'

Zero-dividend preferred stock (also referred to as "capital shares") is a preferred share 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.

BREAKING DOWN 'Zero-Dividend Preferred Stock'

Owners of zero-dividend preference shares will not receive a normal dividend. Often, they still maintain reimbursement priority over common shareholders in the event of bankruptcy. In such an event, they will get a fixed sum that was agreed upon in advance. While a company may structure preferred shares however they choose, most preferred shares will not have voting rights.

Why Zero-Dividend Preference Stock Is Issued

Zero-dividend preferred stock is comparable in some ways to shares and zero coupon bonds, though they can be regarded as lower tier than bonds. Still, they do have upper tier preference compared with common shareholders if a bankruptcy occurs. They may have a set term of up to seven years. This type of stock is usually backed 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.

Typically, holders of preferred stock will get their dividend in advance of common shareholders. In the case of zero-dividend preferred stock, this is not the case. There is no income to be derived for the stockholder. Companies that are likely to issue zero-dividend preferred stock include investment trusts, particularly those that may face challenges getting long-term debt approved.

There are potential issues with zero-preferred stock, such as vulnerability to increasing inflation, just as bonds are. The fluctuations of the market could see this type of stock be outperformed. There is also no guarantee on its yields and the underlying assets could erode in value.

Some of the advantages with zero-dividend preferred stock include the lack of taxes that would normally be warranted on dividends. Furthermore, there is an expectation of a predetermined return within the window of time set for the stock. These shares also are predominantly less volatile compared with equities and bonds.

There is a perception of stability with zero-dividend preferred stock derived from the issuing investment funds and underlying elements such as debt and hurdle rates, which are annual limits on losses that fund managers can accommodate. There may also be issues if the funds are carrying bank debt, particularly when markets are in decline.

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