What is Preferred Stock?

Preferred stock is an equity investment that carries some of the characteristics of debt securities (such as bonds). It usually represents a safer investment than common stock.

It is a form of capital stock that provides dividends and other privileges to its holders. It is a separate class of stock from common stock, and is therefore priced and traded separately from common stock.

Anyone can purchase preferred stock and it can often be converted into common stock at a later stage.

Generally issued by larger blue chip corporations, preferred stock is considered a useful component for stability and income in any investor's portfolio.

What are the differences between common and preferred stock?

If you are a preferred stockholder in a company, you will be paid dividends prior to the holders of common stock (assuming a dividend is declared).

Moreover, in the event of bankruptcy or liquidation of the company, your claim on the assets and distributions of the company rank ahead of those of common stockholders. Note, however, that the claims of debt security holders still precede those of preferred stockholders.

Preferred stock usually carries a fixed dividend payment, whereas the dividend payable to common stockholders depends on the overall performance of the company. Preferred stock dividends are guaranteed and generally higher than those paid on common stock.

Unlike common stock, however, you may not always have voting rights if you purchase preferred stock, as companies can issue both voting and non-voting preferred stock. Furthermore, preferred stock is less liquid than common stock and, because it does not count fully in the company's profits, the growth in value of preferred stock is generally less than that of common stock.

Types of preferred stock

There are a number of different classes of preferred stock that a company may decide to issue, so you may well have to choose which type of preferred stock you wish to purchase.

  • Cumulative preferred stock
    If you are a holder of cumulative preferred stock and you did not receive a past dividend payment for whatever reason, then you are entitled to receive payment of those dividend arrears before any dividend is paid to common stockholders. You should note, however, that the accumulated dividend arrears generally accrue without interest.
  • Convertible preferred stock
    This type of stock comes with a conversion feature which allows you to convert it into common stock of the issuer at a predetermined rate. Investors looking for a direct link to the growth of common stock should consider purchasing convertible preferred stock. But remember that the conversion rate may not necessarily be on a one-to-one basis.
  • Participating preferred stock
    This allows the holder to participate in a further share of the profits of the company by receiving an additional dividend payment after the common stockholders have received a stated amount.
  • Redeemable preferred stock
    In certain circumstances, preferred stock will be redeemable. The issuer will be required to redeem the stock from you either on or before a specified date. Redemption can occur at the par price or for a premium.