Preferred Stock

What is Preferred stock?

Preferred stock is a special class of ownership in a company that comes with unique perks compared to common stock. Think of it as a hybrid between stocks and bonds, offering investors a mix of steady income and a stake in the company, but with less risk than common shares and more than bonds.

What Makes It Different?

1. Dividend Priority: Preferred shareholders get paid dividends before common shareholders. These dividends are usually fixed, like a regular paycheck, set at a specific rate (e.g., 4% of the stock’s par value).
2. Better Claim in Bankruptcy: If the company goes under, preferred shareholders are ahead of common shareholders in line to claim assets, though they rank below bondholders.
3. Limited Say: Most preferred stocks don’t grant voting rights, so you won’t have a voice in company decisions like electing the board.
4. Callable Feature: Some preferred stocks can be bought back by the company at a set price after a certain date, giving the issuer flexibility.
5. Conversion Option: Certain preferred stocks let you swap shares for common stock, which could pay off if the company’s stock price soars.

Types of Preferred Stock

• Cumulative: If the company misses a dividend, those payments stack up and must be cleared before common shareholders get paid.
• Non-Cumulative: Skipped dividends are gone for good, so you might miss out if the company hits a rough patch.
• Participating: You might score extra dividends if the company does exceptionally well, on top of the fixed rate.
• Convertible: These can be turned into common shares, giving you a shot at bigger gains if the stock price climbs.

Why It’s Important?

Preferred stock is a favorite for investors who want reliable income with less volatility than common stock. Its fixed dividends make it a solid pick for those building a portfolio focused on steady cash flow. However, it’s riskier than bonds (dividends aren’t guaranteed) and offers less upside than common stock since share prices don’t typically surge.

Example

Imagine you buy preferred stock in a telecom company with a $100 par value and a 6% dividend rate. You’d get $6 per share each year, paid before common shareholders see a dime. If the stock is cumulative and the company skips a year, you’re still owed that $6 before common dividends restart.

Drawbacks

1. No Voting Power: You’re largely a bystander in company governance.
2. Rate Sensitivity: If market interest rates rise, the fixed dividend looks less attractive, and the stock’s value might dip.
3. Call Risk: The company could repurchase the stock, capping your gains if rates drop.