Preferred stock is a special kind of equity ownership, while bonds are a common form of debt issue. Many consider preferred stock an investment that lands in between common shares and bonds. Despite many similarities, preferred stock is generally riskier than a bond and tends to have higher yields to compensate for that. In the event of corporate bankruptcy proceedings and liquidation, bonds take preference over preferred stock when receiving payments.
Preferred stockholders have a claim to ownership of a corporation just like common stockholders. The structure and rights granted by preferred stock varies from company to company. Unlike common shares, preferred shares do not come with voting rights.
Preferred stock carries characteristics of fixed, dividend-paying securities such as bonds and offers appreciation and possible capital gains such as regular stock. In terms of the distribution of profits, preferred stock dividends are paid before common stock dividends. Additionally, most preferred shares have regularly occurring interest payments. These features make them a more attractive income investment than common shares.
Like bonds, preferred stock is generally callable at the company's option. This gives the issuer the right to call back the security during times of falling interest rates. Typically, the calling of preferred stock is followed by a reissuing of additional lower-yielding preferred stock. Most preferred stock is convertible into common shares.
Corporate bonds are debt instruments, or loans made to the company, which pay interest to the holder until the loan matures, at which point the face value of the bond is repaid. Bondholders do not enjoy voting rights like common shareholders, and they are also not entitled to any dividend payments. They are not owners and do not share in profits.
Bonds are issued at a certain face value, but their actual price in the market fluctuates based on a number of factors, including interest rates and the overall demand for loanable funds. In the event a corporation suffers financial hardship and is forced to declare bankruptcy, bondholders are paid back before any of the company's assets are distributed to shareholders. This feature makes bonds less vulnerable to default risk than other types of securities.
Bonds Vs. Preferred Stock
All bonds have a set maturity date, but this is not necessarily the case for preferred shares, although there are callable redemption dates. Preferred shares can theoretically last forever. However, the interest payments to bondholders are more secure than the dividend payments to preferred shareholders. A company may determine to suspend dividends during times of hardship or capital expansion, while bond payments must be made regardless of financial circumstance.
From an investor's perspective, bonds are safer but offer less upside than preferred stock. Preferred stock tends to have a lower par value and higher yields. It also tends to experience greater price volatility and be less secure than a bond.