CFA CFA Level 1 Question on Reading 49 (Equity Securities)

Question on Reading 49 (Equity Securities)

  • This topic has 6 replies, 4 voices, and was last updated Jun-17 by Zee Tan.
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  • edulima
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    Hi everyone, have a question for you regarding a point made in Reading 49 which I did not quite understand. At the beginning of Section 3.1 (Common shares, page 157 Vol.5), it says that “common shareholders share in the operating performance of the company“, among other things.

    At the beginning of Section 3.2 (Preference shares, page 160 Vol.5), the text says that “preference shareholders do not share in the operating performance of the company“, among other things.

    My question: what does it mean to “share in the operating performance of a company”, and how does this distinction apply to common versus preference shareholders?

    Thanks in advance for any insights into this!

    Zee Tan
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    hey @edulima!

    As far as I know, preferred stock typically pays out a fixed and preferred (i.e. they get paid before common shareholders) dividend, so they’re not tied to the performance of the company (i.e. even if the company doesn’t perform according to expectations the dividend to preferred shareholders is still the same.

    Dividends to common shareholders will obviously be based on performance hence they ‘share in the operating performance of the company’.

    Preferred stock is very similar to being a bondholder: fixed dividends, higher up the creditor’s list compared to common shareholders, no voting rights.

    Hope that helps!

    edulima
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    It does help, @Zee. After your comment, it’s now crystal clear. Thanks!

    greenem
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    Yeah it mainly means the common shareholders dividend depends upon the operating profit (performance) whereas preference shareholders dividends are independent of the net profit/performance.

    Zee Tan
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    No problem @edulima! 😉

    BeanCounter
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    All the above is correct, but it should probably be qualified by saying that it’s only true to the extent of the curriculum and common practice. Preference shares with different terms (eg percentage of profit distributed, etc) also exist.

    Zee Tan
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    @beancounter of course.

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