What is Preferred Stock? Types & Features 

People involved with investing, and those not so inclined, know the stock market well enough. Stock investing has been around for ages. Nonetheless, there are kinds of stocks you can invest in based on the companies they represent, or even based on the nature of the stocks themselves.  

As you may know, the word “stock” represents equity or ownership in any company. Any individual can buy stock and if they do, they become shareholders of the company based on their ownership of shares held. In the stock market, there are two kinds of equity: common stock and preferred stock. Preferred shareholders have a claim on company-issued dividends, but are imposed restrictions on voting rights in any company whose stock they own. This article is about aspects of preferred stock that all investors must know.  

What is preferred stock? 

Preferred stock is also commonly referred to as “preferred shares”. Additionally, the term to define or describe such stock is also “preference shares”. Preferred stock comprises securities that reflect shareholders’ company ownership, and which have a claim, in terms of priority, over common stock on the earnings and assets of the given company. In a sense, preferred shares or preferred stock represents more seniority than common stock but compared to bonds, they are junior (concerning claims on assets).  

The shareholders who own preferred stock have priority over common stockholders in terms of the dividends companies pay out. However, concerning corporate governance and voting rights, the holders of preferred shares have little claim, and are restricted in actions pertaining to these actions regarding their stock-holding.  

Key Features of Preferred Shares 

To get a firm grip on the understanding of preferred stock, you should know the key characteristics of this kind of stock before you make investment decisions. It is important to note, here, that preferred stock has features that make it distinct from common equity and debt. Additionally, you may discover that some features of preferred stock are common to equity or debt instruments. The key features of preferred stock are described below:  

• Liquidation Preference: In case of liquidation of the company issuing preferred shares, preferred stockholders gain priority relative to common shareholders regarding any claim on the assets of the company.  

• Payments of Dividends: The holders of preferred stock have the advantage of receiving regular dividends and this can be viewed as an additional income source for shareholders. The dividend payments may be made on a fixed or a floating basis, depending on the standard followed for deciding interest rates.  

• Dividend Preference: The holders of preferred shares possess a priority when it comes to the payment of dividends compared to the holders of common stock of a given corporation.  

• No Voting Power: Preferred stockholders cannot exert any voting rights, or are restricted in their voting power. Nonetheless, some companies permit preferred shareholders to vote at times of certain events (extraordinary circumstances or events).  

• Callability: The shares owned by preferred shareholders can be bought back by the company (issuer of stock) at particular dates.  

• Conversion to Common Stock: It is possible to convert preferred stock to common stock, provided a preset quantity of shares are determined. In the conversion of preferred stock, some amount of the stock specifies the conversion date. Additionally, if the date is not disclosed for preferred stock conversion, the board of directors of the company must approve the conversion.  

Types of Preferred Stock 

Within the category of preferred stock, there are certain types you should know about. The types of preferred stock are described below:  

• Convertible Preferred Shares: Here, shares of preferred stock can be converted to a pre-fixed quantity of common shares.  

• Exchangeable Preferred Shares: Shares such as these can be exchanged for the acquisition of other kinds of securities.  

• Cumulative Preferred Stock: This may not be considered a “type” of preferred stock in the strict sense. These are preferred stocks whose dividends may not have been paid on time. In such cases, the preferred stock dividends get accumulated and are paid along with subsequent dividends.  

• Preferred Stock in Perpetuity: A type of preferred stock, perpetual preferred stock holds no set date for which shareholders get back their invested capital. This is in contrast to other kinds of preferred stock, much like holding bond investment, where the initial investment is returned to investors after a set maturity period. In the case of perpetual stock, the investor has no choice but to sell the stock to potentially redeem initial investment.  

Advantages of Investing in Preferred Shares 

Preferred stock presents benefits to both investors/holders of the stock, and to issuers, that is, a company that issues it. Here are some key advantages that investors holding the stock get:  

• Secure Position: In case the company that has issued preferred stock gets liquidated, investors remain secure, compared to stockholders holding common stock. This is because preferred shareholders hold a priority claim on the assets of the issuing company.  

• Source of Stable Income: Holding preferred stock potentially ensures investors of getting a steady income via dividend payments from the issuing company. This is viewed as a clear benefit for senior investors and investors with a low tolerance for risk in investment.  

Apart from advantages for investors, preferred shares have perks for companies that issue them. Here are the benefits that issuing companies receive:  

• Flexible Terms: The management of the issuing company of preferred stock enjoys the versatility and flexibility for formulating any terms for holding shares. 

• Control is Not Diluted: Companies are prevented from the dilution of control when they issue preferred shares to investors. This is due to the fact that the holding of preferred stock by investors does not give investors any power over the company regarding voting rights or any other say in company affairs. 

• No Company Obligation to Issue Dividends: Holding company shares does not necessarily mean that shareholders get dividends from preferred shares. The issuing company is under no obligation to deliver dividends. For instance, if issuing companies do not have the means in terms of adequate funds to pay their shareholders, they will likely defer dividend payment.  

Conclusion 

Preferred equity or preferred stock reflects the ownership of a company by owning its stock. Preferred stock is often compared with common stock, and investors should know these concepts to make informed decisions while investing. Additionally, preferred stock yields an income for the shareholders that own it, in the form of regular dividends that the company pays. Therefore, investors who are seeking the generation of a cash flow, such as risk-averse investors or senior citizens, may consider these stocks for investment.  

It is important to note that preferred stock reflects a shareholder’s company ownership via the stock they own and prioritised treatment in terms of dividend distributions. However, while investing in this stock may yield income in the form of dividends, its capital appreciation tends to be slow, or even low, at times. Anyway, when you invest, you should do so based on your unique investment goals and plans, not to mention considering your risk tolerance level.