Loading the player...

What is a 'Preferred Stock'

A preferred stock is a class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. Preferred shares generally have a dividend that must be paid out before dividends to common shareholders, and the shares usually do not carry voting rights.

Preferred stock combines features of debt, in that it pays fixed dividends, and equity, in that it has the potential to appreciate in price. The details of each preferred stock depend on the issue. 

BREAKING DOWN 'Preferred Stock'

Preferred shareholders have priority over common stockholders when it comes to dividends, which generally yield more than common stock and can be paid monthly or quarterly. These dividends can be fixed or set in terms of a benchmark interest rate like the LIBOR​. Adjustable-rate shares specify certain factors that influence the dividend yield, and participating shares can pay additional dividends that are reckoned in terms of common stock dividends or the company's profits.

Companies in Distress

If a company is struggling and has to suspend its dividend, preferred shareholders may have the right to receive payment in arrears before the dividend can be resumed for common shareholders. Shares that have this arrangement are known as cumulative. If a company has multiple simultaneous issues of preferred stock, these may in turn be ranked in terms of priority. The highest ranking is called prior, followed by first preference, second preference, etc.

Preferred shareholders have a prior claim on a company's assets if it is liquidated, though they remain subordinate to bondholders. Preferred shares are equity, but in many ways, they are hybrid assets that lie between stock and bonds. They offer more predictable income than common stock and are rated by the major credit rating agencies. Unlike with bondholders, failing to pay a dividend to preferred shareholders does not mean a company is in default. Because preferred shareholders do not enjoy the same guarantees as creditors, the ratings on preferred shares are generally lower than the same issuer's bonds, with the yields being accordingly higher.

Voting Rights, Calling and Convertibility

Preferred shares usually do not carry voting rights, although under some agreements these rights may revert to shareholders that have not received their dividend. Preferred shares have less potential to appreciate in price than common stock, and they usually trade within a few dollars of their issue price, most commonly $25. Whether they trade at a discount or premium to the issue price depends on the company's credit-worthiness and the specifics of the issue: for example, whether the shares are cumulative, their priority relative to other issues, and whether they are callable.

If shares are callable, the issuer can purchase them back at par value after a set date. If interest rates fall, for example, and the dividend yield does not have to be as high to be attractive, the company may call its shares and issue another series with a lower yield. Shares can continue to trade past their call date if the company does not exercise this option.

Some preferred stock is convertible, meaning it can be exchanged for a given number of common shares under certain circumstances. The board of directors might vote to convert the stock, the investor might have the option to convert, or the stock might have a specified date at which it automatically converts. Whether this is advantageous to the investor depends on the market price of the common stock.

Typical Buyers of Preferred Stock

Preferred stock comes in a wide variety of forms. The features described above are only the more common examples, and these are frequently combined in a number of ways. A company can issue preferred shares under almost any set of terms, assuming they don't fall foul of laws or regulations. Most preferred issues have no maturity dates or very distant ones.

Due to certain tax advantages that institutions enjoy with preferred shares but individual investors do not, these are the most common buyers. Because these institutions buy in bulk, preferred issues are a relatively simple way to raise large amounts of capital. Private or pre-public companies issue preferreds for this reason.

Preferred stock issuers tend to group near the upper and lower limits of the credit-worthiness spectrum. Some issue preferred shares because regulations prohibit them from taking on any more debt, or because they risk being downgraded. While preferred stock is technically equity, it is similar in many ways to a bond issue; some forms, known as trust preferred stock, can act as debt from a tax perspective and common stock on the balance sheet. On the other hand, several established names like General Electric, Bank of America and Georgia Power issue preferred stock to finance projects. 

For more on this interesting hybrid security, read "A Primer on Preferred Stocks" and "Valuation of Preferred Stocks."

RELATED TERMS
  1. Preference Shares

    Preference shares are company stock with dividends that are paid ...
  2. Preferred Dividend

    A preferred dividend is one that is accrued and paid on a company's ...
  3. Current Dividend Preference

    A safety feature that is offered to a company's preferred shareholders, ...
  4. Participating Preferred Stock

    Participating preferred stock gives the holder the right to earn ...
  5. Cumulative Preferred Stock

    Cumulative preferred stock has a provision that says if any dividends ...
  6. M

    The fifth letter of a Nasdaq stock symbol indicating an issue ...
Related Articles
  1. Investing

    Preferred stocks: A primer

    Offering both income and relative security, these uncommon shares may work for you.
  2. Managing Wealth

    What You Need To Know About Preferred Stock

    Curious about preferred shares? Here's what you should know about these bond-like instruments.
  3. Investing

    Investing in Preferred Stock:The Basics

    Preferred stocks provide income as well as the potential to appreciate in value.
  4. Managing Wealth

    The Different Between Preferred and Common Stock

    Preferred and common stocks are different in two key ways.
  5. Investing

    Introduction to Convertible Preferred Shares

    These securities offer an answer for investors who want the profit potential of stocks but not the risk.
  6. Financial Advisor

    4 Reasons a Company Might Suspend Its Dividend

    Learn about the four most common reasons a company may choose to suspends its dividends, including financial trouble, funding growth and unexpected expenses.
  7. Insights

    Why Warren Buffett Prefers Preferred Stock (GS, BAC)

    Warren Buffett recently made a tidy profit his investment in Kraft Heinz's preferred stock. He's pulled this off before, with Goldman Sachs and Bank of America. What makes this kind of stock ...
  8. Investing

    The Right Way to Preferred Stocks Right Now

    Preferred stocks can be vulnerable to rising interest rates, but this ETF can help solve that problem.
  9. Investing

    Pros and Cons: Preferred Stock ETFs vs. Bond ETFs

    A look at the differences between preferred stock ETFs and bond ETFs and when you should invest in one over the other.
RELATED FAQS
  1. Why would a company issue preference shares instead of common shares?

    Learn about some reasons that corporations might issue preference or preferred shares, and why investors might value them ... Read Answer >>
  2. What are the advantages and disadvantages of preference shares?

    Learn about the advantages and disadvantages of preference shares for both investors and issuing companies. Read Answer >>
  3. What is the difference between preference and ordinary shares?

    Preferred shareholders have a higher priority claim to the assets of a corporation in case of insolvency than common shareholders. Read Answer >>
  4. Do Preferred Shares Offer Companies a Tax Advantage?

    Find out if there is a tax advantage for corporations issuing preferred shares when compared to other forms of financing ... Read Answer >>
Hot Definitions
  1. Current Assets

    Current assets is a balance sheet account that represents the value of all assets that can reasonably expected to be converted ...
  2. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  3. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  4. Cost of Debt

    Cost of debt is the effective rate that a company pays on its current debt as part of its capital structure.
  5. Depreciation

    Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life and is used to account ...
  6. Ratio Analysis

    A ratio analysis is a quantitative analysis of information contained in a company’s financial statements.
Trading Center