Preferred Stock

What Is Preferred Stock and How Does It Differ From Common Stock?

Preferred stock is a unique type of equity that grants shareholders priority over common stockholders in terms of dividend distribution and — in the event a company goes bankrupt — asset distribution.
Additionally, most preferred stock comes with a fixed, regular dividend, unlike common stock, for which dividends might possibly be paid at some random interval at the company's discretion. Companies can, however, lower or discontinue dividend payments on preferred shares assuming earnings slump, yet solely after discontinuing any dividend payments on common shares.
Unlike common stock, preferred stock generally does not bestow shareholders with voting rights (and when it does, these rights are normally limited). Additionally, because of the fixed income payments preferred stock regularly comes with, it is typically less volatile in price than common stock, as less of its value is derived from company performance.
Preferred stock shares don't mature similarly corporate bonds do, however for the most part, they do have a date after which they are callable. This means they can be returned to the company by investors for their par value. Like common shares, preference shares do have market value, yet it doesn't typically wander particularly distant from par value, which is the original share value based on which dividend yield is calculated.
Overall, preferred stock can be considered a cross between common stock and a corporate bond in that it has characteristics of both an equity instrument (like company ownership) and a debt instrument (like fixed income payments).

What Are the Advantages of Owning Preferred Stock?

Because its value comes generally from its fixed dividend payments, preferred stock is normally more stable in price than common stock, and this stability can be advantageous during times of economic uncertainty. Additionally, the dividends paid to preferred shareholders are ordinarily higher than those paid (if any) to common stockholders.
In some cases, preferred shares are convertible, meaning they can be exchanged for a predetermined number of shares of common stock. This can permit investors to switch gears, in a manner of speaking, from fixed income payments to potential capital gains.
In the event a company can't afford to pay dividends to all shareholders, preferred shareholders take priority over common stockholders. Essentially, in the event that a company goes bankrupt and must liquidate its assets to pay creditors, preferred shareholders are paid before common stockholders.

What Are the Disadvantages of Owning Preferred Stock?

Preferred shares generally don't come with voting rights (and when they do, they are normally limited), so preferred stockholders don't ordinarily have a lot of say in a company's elections and major business decisions.
Additionally, because preferred shares aren't very volatile, they are less likely to go up fundamentally in value in response to company success. Of course, in the event that an investor is holding convertible preferred shares, they could exchange them for shares of common stock to make a profit assuming share price goes up fundamentally, however not all preferred shares are convertible.

For what reason Do Companies Issue Preferred Stock?

Companies issue preferred stock for the same general reason they take out loans or issue corporate bonds or common stock — to raise capital. That being said, preference shares do have some advantages over these other money generating activities.
In the first place, preference shares, despite their similitude to corporate bonds, count as equity, so giving them lowers a company's debt-to-equity ratio, the most famous leverage ratio investors and analysts use to evaluate company debt-related health. Giving corporate bonds, then again, raises a company's D/E ratio, which doesn't send as good of a signal to the public.
Additionally, preference shares don't come with voting rights, so giving them doesn't take any decision-production power away from management.

Advantages and disadvantages of Preferred Stock

Pros	Cons
Regular dividends	Few or no voting rights
Low capital loss risk	Low capital gain potential
Right to dividends before common stockholders	Right to dividends only if funds remain after interest paid to bondholders
Right to assets before common stockholders	Right to assets only after bondholders have been paid

## What Are the Differences Between Preferred Stock and Corporate Bonds? Corporate bonds and preferred stock share numerous characteristics however are not totally alike. Both pay holders on a regular premise — bonds by means of interest payments and preferred shares through dividend payments — and both are issued by companies to raise capital for operations. Corporate bonds and preference shares do, however, differ in more than one way. To start with, bonds mature, at which point the principal must be repaid to the holder. Preference shares, then again, do not mature, despite the fact that they might be resold on the open market whenever, or on the other hand assuming callable, be returned to the company for their par value after a certain date. Additionally, bondholders have higher priority than preference shareholders when it comes to both income payments and asset distribution. On the off chance that a company is battling with earnings, it will pay its bondholders interest before paying any dividends to preference shareholders. Should a company become insolvent and fail, the proceeds of its asset liquidation will likewise be distributed to bondholders before preference shareholders. Furthermore, bonds are loans, so they do not grant their holders any ownership of the underlying company. Preference shares, then again, are equity instruments and do represent company ownership, albeit generally without voting rights. ## What Types of Investors Buy Preferred Stock? Preferred stock is most frequently purchased in bulk by institutional investors for its tax advantages, yet when it comes to individual (AKA "retail") investors, those who buy a great deal of preferred stock tend to be relatively risk-averse investors seeking regular passive income payments (e.g., dividend investors). During market slumps, [bear markets](/bearmarket), and [recessions](/recession), preferred shares often become well known with a wider variety of investors due to their relative stability compared to common stock and their fixed dividend payments. ## Are Preferred Shares Debt or Equity Instruments? Preferred shares are technically equity instruments, as they represent ownership in a company, yet they share numerous characteristics of debt instruments like corporate bonds. For example, their market value is less volatile than common equity, they provide fixed income payments, and many are callable, meaning they can be returned to the underlying company after a certain date for par value. Because they share such countless features with bonds, numerous investors consider preferred stock to be a kind of hybrid [security](/security). ## Famous Preferred Stock ETFs - iShares Preferred and Income Securities ETF (NASDAQ: PFF) - Invesco Preferred ETF (NYSEARCA: PGX) - Innovator S&P Investment Grade Preferred ETF (BATS: EPRF) - Principal Spectrum Preferred Securities Active ETF (NYSEARCA: PREF)

Features

Preferred stock has characteristics of the two bonds and common stock which enhances its appeal to certain investors.
In the event of a liquidation, preferred stockholders' claim on assets is greater than common stockholders however less than bondholders.
Preferred stockholders generally have no or limited, voting rights in corporate governance.
Preferred stockholders have a higher claim on distributions (e.g. dividends) than common stockholders.

FAQ

What Is the Difference Between a Preferred Stock and a Common Stock?

While preferred stock and common stock are both equity instruments, they share important distinctions. To start with, preferreds receive a fixed dividend as dividend obligations to preferred shareholders must be satisfied first. Common stockholders, then again, may not necessarily in all cases receive a dividend. Secondly, preferreds normally do not share in the price appreciation (or depreciation) to the same degree as common stock. Finally, preferred ordinarily have no voting rights, whereas common stockholders do.

What Is an Example of a Preferred Stock?

Consider a company is giving a 7% preferred stock at a $1,000 par value. Thusly, the investor would receive a $70 annual dividend, or $17.50 quarterly. Commonly, this preferred stock will trade around its par value, behaving more much the same way to a bond. Investors who are hoping to generate income might choose to invest in this security. The most common sector that issues preferred stock is the financial sector, where preferred stock might be issued as a means to raise capital.

What Are the Advantages of a Preferred Stock?

A preferred stock is a class of stock that is granted certain rights that differ from common stock. Namely, preferred stock often possesses higher dividend payments, and a higher claim to assets in the event of liquidation. In addition, preferred stock can have a callable feature, and that means that the issuer has the privilege to redeem the shares at a predetermined price and date as indicated in the prospectus. In numerous ways, preferred stock shares comparable characteristics to bonds, and because of this are sometimes referred to as hybrid securities.