Preferred Stock: Definition, Types, and vs. Common Stock - Stock Analysis (2024)

Preferred stock is a category of stock that comes with certain rights or features that are different than those granted to common stockholders.

Preferred stock shares may include aspects of both debt and equity instruments, making them somewhat of a hybrid stock form.

Preferred stock is also called preferred shares, preferreds, or sometimes preference shares.

Here is a complete guide to preferred stock, including benefits and limitations, types, and how these shares compare to bonds and common stock.

What is preferred stock?

Preferred Stock: Definition, Types, and vs. Common Stock - Stock Analysis (1)

Preferred stock is a class of stock that can have both debt and equity characteristics.

For this reason, it can share features with both common stock and bonds, though it has some unique privileges attached to it as well.

Like bonds, the value of preferred sharesis sensitive to interest rate changes. And like common stock, preferred shares represent a form of equity in the company.

Importantly, preferred stock shares offer some privileges that are not available to those holding common stock shares. For example, preferred stockholders have a greater claim on assets in the event of a liquidation. They also have a greater claim on dividends.

However, preferred shares rarely give the holder the right to vote on the company's corporate governance, so preferred shareholders have no control over the business's management.

The terms of the preferred stock will be outlined in the company's articles of association or incorporation.

Of note, insurance companies and banks are the kinds of companies most likely to offer preferred shares.

Summary

Preferred stock is a class of stock that has certain rights assigned to it, such as a greater claim on assets following a liquidation. It differs from common stock in that it does not grant voting rights.

Benefits of preferred stock

Preferred stock has several beneficial features, such as higher dividends, increased protection in the event of company liquidation, and price stability.

Higher dividends

One of the biggest benefits of preferred stock is the dividends, which are:

  • Often fixed at a certain rate, though not always.
  • Usually much greater than those offered to common stockholders.
  • Set to occur at regular intervals.
  • Prioritized over common stock dividends.

Common stock does not offer this level of certainty when it comes to dividends, because payments may decrease or stop entirely.

Moreover, preferred stock dividends are paid before common stock dividends.

This predictability is a major feature of preferred stock and often attracts buy-and-hold investors focused on a long-term strategy designed to accumulate dividend income.

More protection

Preferred shareholders have priority over common shareholders if the company is forced to liquidate. In this scenario, preferred shareholders have a prior claim on the company's assets.

However, it should be noted that bondholders still have priority over preferred shareholders.

Price stability

The price of preferred shares is generally more stable than that of common stock.

Preferreds are generally issued with a par value, or face value, and trade more similarly to bonds, with sensitivity to interest rates. What this means is that you're not investing for growth necessarily, but rather for the income.

As a preferred shareholder, you're not likely to experience a sharp rise or even a gradual long-term rise in the share price if the company becomes successful.

However, there are some scenarios in which a preferred shareholder could experience capital gains, such as:

  • Buying a preferred stock before an interest rate drop.
  • Owning preferred stock when the firm's creditworthiness increases.

For most preferred shareholders, the true value of the shares is the size and predictability of the dividends, not a potentially larger future share price.

Summary

Preferred stock comes with several advantages, including more predictable dividends, some protection if the company were to liquidate, and stable value.

Limitations of preferred stock

Alongside the benefits come a few drawbacks, such as no voting rights and a lack of growth.

No voting rights

Preferred shares rarely offer voting rights. Consequently, the holder has no say in the decisions made by the executives or in the management of the company.

While this may not be a serious drawback for investors, there could be a scenario in which a major proxy vote outcome has a big influence on the future of the company and, by extension, the value of the preferred stock.

Price stability

Preferred shares do not rise and fall in value the way common shares do.

This means that preferred shareholders do not get to participate in the capital gains that may come from holding common stock in companies experiencing share price appreciation.

However, this can be either a benefit or limitation, depending on how you look at it and what your investment strategy is.

Summary

The downside of preferred stock is the lack of voting rights and the fact that preferred shares don't have the opportunity to majorly appreciate in value.

Types of preferred stock

There are four main types of preferred stock: convertible, callable, cumulative, and participatory.

1. Convertible

These shares of preferred stock can be converted later on to common shares.

Some investors might want this type of preferred stock because they may want to capitalize on a rising share price. However, note that the conversion is a one-time thing.

Companies often use convertible shares in early-stage financing. This offers early investors a return with the opportunity for growth in the company.

The downside, of course, is that the conversion opportunity may not appreciate, or could even depreciate, depending on how the company performs.

2. Callable

With this type of stock, the issuing company has the right to call, or repurchase, the shares at a set price on a defined date.

The company might choose to do this if they decide the interest rates they're required to pay are too burdensome. The call price, the call date, and the call premium, which is not always offered, are all clearly defined in the prospectus. None of these can be changed later.

Callable preferred stock gives the issuer flexibility.

For example, they might issue 6% preferred shares. Then, when interest rates decrease, they may choose to issue preferred shares at 4%, allowing them to call in the more expensive shares and issue new ones at a lower dividend rate.

The investor's advantage is that the issuer usually pays a call premium upon the redemption of the preferred issue, which compensates the investor for having to sell the shares.

Also, if the issuer has additional optionality, they must pay the investors for it.

3. Cumulative

Cumulative preferred stock includes a provision stating that if the issuer misses any dividend payments they must pay all of those missed payments before making any dividend payments to common shareholders or other classes of preferred stock shareholders.

Those holding common stock or preferred shares that are not cumulative simply miss out if a dividend payment is not made.

Cumulative preferred stock is good to have when a company encounters financial hardship and then recovers. After the recovery, the cumulative preferred stock shareholders get to catch up on the payments they did not receive.

4. Participatory

Participatory preferred stock allows the holder to participate in higher-than-expected revenues.

These shareholders can receive higher dividend payments than the fixed amount if the issuing company generates more revenue than anticipated.

Typically, this additional payment happens when the common share dividend is higher than the preferred share dividend.

For example, let's say a company issues participating preferred shares at a dividend rate of $2.50 per share. Then, the company announces it will pay a dividend of $3.00 per share for common shares. Preferred shareholders will receive the higher payment, so $3.00.

Summary

There are four kinds of preferred shares: convertible, callable, cumulative, and participatory. All of them offer unique benefits to the holder.

Preferred stock vs. common stock and bonds

While preferred stock shares some similarities with common stock and bonds, there are a few key differences as well.

Preferred stock vs common stock

Similarities

Preferred stock and common stock both:

  • Offer equity ownership in a company.
  • Are tradeable on public exchanges.

Differences

Preferred stock and common stock differ because preferred stock:

  • Has first right to dividends, while common stock does not guarantee dividends.
  • Rarely generates any chance at capital appreciation, while common stock does.
  • Offers priority to holders in event of liquidation, whereas common stock does not.
  • Is sometimes convertible to common stock but common cannot be converted to preferred.
  • Holds no voting rights, while common stock does.

Preferred stock vs bonds

Similarities

Preferred stock and bonds both:

  • Offer recurring cash distributions.
  • Are offered at par value or face value.

Differences

Preferred stock and bonds differ because preferred stock:

  • Is prioritized above common stock in liquidation, though bonds are prioritized above all.
  • Rarely has an end date, while bonds have a fixed term or maturity date.
  • Can experience changes in dividend amounts, while bonds often have set interest payments, though not always.
Summary

The main differences between preferred stock, common stock, and bonds are the rights they grant the shareholder.

Comparison guide

Below is a table that summarizes the similarities and differences discussed above.

Preferred stockCommon stockBonds
Equity ownershipYesYesN/A
Tradable on public exchangesYesYesNo
First right to dividendsYesNoN/A
Can appreciateNoYesN/A
Priority in liquidationYesNoTop priority
ConvertibleYesNoN/A
Voting rightsNoYesN/A
Recurring cash distributionYesNoYes
Offered at face valueYesNoYes
Maturity dateNoN/AYes
Payments can fluctuateYesYesNo

The takeaway

Preferred stock is a class of stock granting certain rights to shareholders. These differ from the rights associated with common stock, though there are pros and cons to each.

The main differences are which rights are granted to shareholders and how the returns work.

Preferred stock is often favored byinvestors who want relatively high dividend payments that offer consistency and some downside protection in the event of the issuer experiencing financial hardship or even liquidation.

There are four kinds of preferred shares, all of which offer unique benefits to the holder. There is no optimal type — choosing the right kind means knowing which best suits the investor's goals.

Preferred Stock: Definition, Types, and vs. Common Stock - Stock Analysis (2024)

FAQs

Preferred Stock: Definition, Types, and vs. Common Stock - Stock Analysis? ›

The main difference between preferred and common stock is that preferred stock gives no voting rights to shareholders while common stock does. Preferred shareholders have priority over a company's income, meaning they are paid dividends before common shareholders.

What is the difference between preferred stock and common stock? ›

Preferred stock is a distinct class of stock that provides different rights compared with common stock. While both types confer ownership in a company, preferred stockholders have a higher claim to the company's assets and dividends than common stockholders.

What is the difference between common and preferred stock preferred stock quizlet? ›

What is the difference between preferred and common stock? Preferred stock has no voting privileges but common stock does. Preferred stock has their stock holders get paid first. Common stock pays their dividend after preferred stock holders.

What are the 8 types of preference shares? ›

Types of Preference Shares
  • Convertible Preference Shares.
  • Non-Convertible Preference Shares.
  • Redeemable Preference Shares.
  • Non-Redeemable Preference Shares.
  • Participating Preference Shares.
  • Non-Participating Preference Shares.
  • Cumulative Preference Shares.
  • Non-Cumulative Preference Shares.

Why would a company issue preferred shares instead of common shares? ›

Investors value preference shares for their relative stability and preferred status over common shares for dividends and bankruptcy liquidation. Corporations mostly value them as a way to obtain equity financing without diluting voting rights and for their callability.

Is it better to sell common or preferred stock? ›

Common stock has higher long-term growth potential than preferred stock but also has lower priority for dividends and a payout in the event of a liquidation. Lenders, suppliers and preferred shareholders are all in line for a payout ahead of common stockholders.

Can you sell preferred stock at any time? ›

Preferred stocks often have no maturity date, but they can be redeemed or called by their issuer after a certain date. The call date will depend on the issuing company. There is no minimum or maximum call date, but most companies will set the date five years out from the date of issuance.

Is preferred stock callable or redeemable? ›

Redeemable preferred stock is a type of preferred stock that includes a provision allowing the issuer to buy it back at a specific price and retire it. Also known as callable preferred stock, redeemable preferred stock can be advantageous for issuers because it gives them more financial flexibility.

What is an example of a preferred stock? ›

What Is an Example of a Preferred Stock? Consider a company is issuing a 7% preferred stock at a $1,000 par value. In turn, the investor would receive a $70 annual dividend, or $17.50 quarterly. Typically, this preferred stock will trade around its par value, behaving more similarly to a bond.

What is another name for preferred stock? ›

Preferred stock (also called preferred shares, preference shares, or simply preferreds) is a component of share capital that may have any combination of features not possessed by common stock, including properties of both an equity and a debt instrument, and is generally considered a hybrid instrument.

What are the disadvantages of preferred stock? ›

That means it might be harder to buy or sell your preferred stocks at the prices you seek. To sum it up: Preferred stocks are usually less risky than common dividend stocks, and carry higher yields, but lack the opportunity for price appreciation as the issuing company grows. They also go without voting rights.

Why choose preferred stock? ›

Preferred stock is attractive as it usually offers higher fixed-income payments than bonds with a lower investment per share. Preferred stockholders also have a priority claim over common stocks for dividend payments and liquidation proceeds. Its price is usually more stable than common stock.

How do I know if my shares are common or preferred? ›

You can usually tell the difference between a company's common and preferred stock by glancing at the ticker symbol. The ticker symbol for preferred stock usually has a P at the end of it, but unlike common stock, ticker symbols can vary among systems; for example, Yahoo!

Why would you buy preferred stock? ›

Preferred stock is attractive as it usually offers higher fixed-income payments than bonds with a lower investment per share. Preferred stockholders also have a priority claim over common stocks for dividend payments and liquidation proceeds. Its price is usually more stable than common stock.

Why would a company convert preferred stock to common stock? ›

Preferred stockholders can be forced to convert their preferred stock to common stock in a few situations: IPO. When a company holds its initial public offering (IPO), it is expected that all outstanding preferred stock will convert to common stock immediately before the IPO.

What are the disadvantages of preference shares? ›

Disadvantages Of Preference Shares

The key disadvantage of owning preferred shares is the absence of ownership rights in the business. From an investor perspective, the business is not liable to preferred shareholders as opposed to equity shareholders.

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