Preferred Equity/Total Equity (%)Preferred equity differs from common equity in that certain investors are given preference relative to the common equity in the distribution of cash flows. Typically in a preferred equity investment, all cash flow or profits are paid back to the preferred investors (after all debt has been repaid) until they receive the agreed upon “preferred return,” for example, 12%. Remaining distributions of cash flow are returned to common equity holders. Investors seeking a higher yielding, but steady return, may invest in preferred equity. They forgo a larger potential overall return for consistent cash flow and less relative risk.
We penalise companies that have issued preferred equity and where it is becoming increasingly material. Preference shares tend to be issued by heavily leveraged companies, sometimes as a tax-advantaged way to increase their borrowing power. Only 5% of companies within our database of 16,000 have issued some form of preference shares. Philippine, Russian and Korean companies have the highest incidence of issuance, at 14-33%, although amounts tend to be immaterial relative to total equity.
Our accounting screen is set to trigger a red flag when companies have issued preference shares and/or when there is an abnormally large increase relative to the normal rate of change amongst global peers over one and three years. This latter red flag is triggered when the increase in preference shares/total equity exceeds the 80th percentile relative to the change experienced by the global sample between 2010 and 2015.