Preferred stock is a type of stock that gives an investor different rights than other types of stock like common stock. It has many of the same aspects of bonds and common stock and is sometimes considered a hybrid of both.
Companies that issue preferred stock often pay dividends to preferred shareholders, making it an enticing investment vehicle for those looking for fixed-income investments.
Having shares of preferred stock instead of common stock may boost investors’ income, but it doesn’t have the same voting rights as common shares. So why would an investor choose preferred stock vs common stock? Let’s dig in and find out.
Table of Contents:
- What is a preferred stock?
- How does a preferred stock work?
- How does a preferred stock differ from common stock?
- Types of preferred stock
- What are the advantages of preferred stock?
- What are the disadvantages of preferred stock?
- How to buy preferred stocks on Public
What is a preferred stock?
Preferred stockholders are given priority over other shareholders and receive more earning income, or dividends, from the company. Preferred stock is similar to bonds in this way, as shareholders often receive regular and consistent payments, just as bond holders receive interest payments.
Unlike bonds or debt, it doesn’t need to be repaid.
And the dividends are not guaranteed, so a preferred stockholder could lose out on income if the company goes in the red or chooses to end dividend payments (although preferred stockholders often receive dividends even if common stock dividends are reduced or eliminated). Preferred stock takes priority over common stock, even in the case of bankruptcy.
So if a company goes bankrupt, bondholders are paid back first, followed by preferred shareholders, and common stockholders receive whatever is left, if anything.
However, preferred stock has less price appreciation potential and has little or no voting rights. Preferred shareholders do not get a say in company decisions like mergers, stock splits, or other corporate events.
How does a preferred stock work?
Preferred stock and other types of securities like common stock or even bonds are issued by companies to raise capital and run their business or invest in new growth ventures. Not every company issues preferred stock. Generally, it’s issued by companies who have more debt issuance restrictions, like banks, insurance companies, utility companies and real estate companies like REITs.
A company might decide to issue preferred stock instead of another type of security for a few different reasons.
For one, preferred shares often have a shorter maturity date than bonds. It’s also less risky than issuing bonds, as a company could face bankruptcy if it fails to meet a bond payment. It also keeps a company’s debt-to-equity ratio lower.
A company that issues preferred stock can instead defer its dividend payments, giving the company more flexibility. Preferred stock also doesn’t have voting rights, which gives a company more control, especially if they have a large number of common shares already.
Preferred stock works similar to common stock in how it is issued but differs on a few things. For one, preferred stock will have a par value, which is how the dividend is calculated. For example, a company that issues preferred shares with a par value of $1,000 and a dividend of 5%, then the issuer of the stock must pay that rate per year as long as the shares are outstanding.
How does a preferred stock differ from common stock?
Both common stock and preferred stock are issued by companies to raise capital and give holders ownership of a company. Both can be purchased through a brokerage firm like Public. Common stock is generally more well-known and is issued by publicly traded companies. Preferred stock is not issued by all companies and isn’t issued as frequently. In fact, many blue-chip stocks don’t issue preferred stock at all.
Some of the other key differences between the two include:
- Dividends: Preferred shareholders receive any planned dividends before common shareholders. That means if a company is struggling, preferred shareholders will receive preferred dividends before those who hold common stock.
- Priority: Shareholders who have preferred stock are paid before common shareholders in the event of a liquidity event such as bankruptcy. Creditors like bondholders will be paid first, but preferred shareholders are paid second.
- Voting rights: Preferred shareholders usually don’t have any voting rights. Common stock, however, comes with voting rights. That means shareholders can vote on company events like acquisitions, mergers, who is added to the board of directors, and more.
- Pricing: Because preferred shares act more like bonds than stocks, they are priced differently than common stock. Preferred shares are generally traded at a stable price, as the company’s share price generally doesn’t impact the value of the preferred stock. That’s because investors instead rely on dividends to get a return on their investment.
In addition, preferred shares are rated for financial strength in the same way as bonds. The price of common stock fluctuates more and is more influenced by things like movement in the stock market and company news.
Types of preferred stock
There are different types of preferred stock that a company can issue including:
- Cumulative preferred shares: The dividends on these shares accrue if the company chooses to defer dividend payments. Dividends must be paid to preferred shareholders before any common stock shareholders.
- Non-cumulative preferred shares: Dividends are not accrued, meaning if the company decides to limit or stop paying dividends, the shareholder will not receive any, even in the future.
- Trust-preferred shares: Shares that are issued through a trust and funded by debt securities, and mature at the same as the debt securities. They are not issued as much as they were in the past due to regulations.
- Convertible preferred stock: These are shares that can be converted into common shares if the shareholder chooses.
- Exchangeable preferred stock: These shares can be exchanged for another type of security.
What are the advantage of preferred stock?
- More price stability than common stock
- Dividends are prioritized over common stock dividends
- In case of insolvency, preferred shareholders are paid back before common shareholders
What are the disadvantages of preferred stock?
- Little or no voting rights
- Dividends paid after interest paid to bondholders
- Low capital gain potential
How to buy preferred stocks on Public
An investor who wants to diversify their portfolio and is looking for fixed income investments might want to consider buying preferred stocks. Because they act closer to how bonds work, some experts consider preferred stock a lesser risk investment than common stock.
If you are thinking about buying preferred stock, the first thing to do is look at the preferred stock rating. Like bonds, preferred stocks have a credit rating that can help you figure out if you should buy the stock or not. With Public Premium you can get access to extra data about a company, including its credit rating and earnings reports, to help you figure out if a stock is the right investment for you.
Once you decide if you want to buy a stock, you can look up the stock on the Public app. Make sure you have funds in your account, then decide how much to buy. Once you have determined how much stock to buy, you can place an order on the app.
What’s the difference between preferred stock and common stock?
The biggest difference between preferred stock and common stock is that preferred stock doesn’t have any voting rights, while those who hold common stock do. Preferred shareholders also get priority when it comes to a company’s income. This means priority shareholders receive dividend income before common shareholders if the company has trouble meeting its obligations.
Are preferred shares a good idea?
Preferred shares are usually less risky than common stock. Whether or not they are a good idea depends on your personal investing portfolio and investing objectives.
Is it better to buy common or preferred stock?
Buying common or preferred stock is not necessarily better than the other, as it depends on the individual investor. An investor who wants their capital to appreciate in value might find common stock suits them better, while an investor who wants a less risky investment that pays dividends might decide to look into preferred stock.
What are some benefits of preferred stock?
Some of the benefits of preferred stock include getting an annual dividend and having the advantage of being paid before common stock holders in the case of insolvency.
Why would a company issue preferred stock?
A company might issue preferred stock because they need to raise capital but don’t want to go into debt or give shareholders more voting power.