What is a Perpetual Preferred Stock
A perpetual preferred stock is a type of preferred stock that has no maturity, or no specific buyback date, although they do have redemption features. Unless redeemed, issued perpetual preferred stock will pay dividends indefinitely. They trade on stock exchanges similar to common stock.
What Are Stocks?
BREAKING DOWN Perpetual Preferred Stock
There are two types of preferred stocks, called perpetual and non-perpetual. Perpetual stock gives the company the right to buy back the stock at any time under specific terms defined in the prospectus. This buyback period is basically a call feature, well-known in the bond market. A non-perpetual stock has a particular buyback price and buyback date, usually 30 or more years from the date of issue.
Companies buyback perpetual preferred shares for several reasons, including changes in interest rates and tax laws. Investors must bear this in mind because losing their shares to a redemption means they will suddenly lose an income stream. Due to changes in interest rates, the investors may not be able to reinvest their money and receive the same dividend rate. The non-perpetual preferred stock has a defined maturity date and therefore has more certainty regarding cash flows.
A perpetual preferred stock is also similar to a bond with an extremely long maturity date.
Preferred Stock vs. Bonds
Investors put their money in a preferred stock because it combines the ease and trading benefits of stocks with the fixed income benefits of bonds. Holders of all types of preferred stock receive priority over common stockholders. This preference is significant when it comes to the payment of dividends and voluntary liquidation of assets, but is essential in bankruptcy situations. During a bankruptcy, preferred stockholders receive first shot at the company's asset liquidation.
However, unlike common stock, investors in preferred shares do not get a direct benefit from increases in the company’s earnings. They are only entitled to the dividend in-force when they purchased their shares. As an example, an investor buys a preferred stock when the dividend payment is $10 per year. The company later raises that payment to $15 per year. The holder of the preferred share gets only the $10 dividend, but the common stockholder will receive the higher dividend.
Companies can issue bonds or preferred stock for many reasons. It is important to consider whether the company's balance sheet is already loaded with debt before buying either one. Adding more debt might risk a credit downgrade or a problem with regulators. Individuals get no tax benefit from owning preferred stock, however, corporations do. Preferred stocks offer greater protection than common stocks if the company claims bankruptcy. Preferred shares likely offer higher yields than an equivalent bond.
There are many risks to consider before buying preferred shares. Indeed, a good deal of preferred stock is issued by companies with lower credit ratings. Also, the board of directors can vote to suspend the dividend payments, and the preferred stockholders cannot sue them.