Preferred stocks are hybrid investments that combine features of stocks and bonds. They offer perks like priority over common shareholders during dividend or asset payouts. However, they may not confer voting rights, and the company may retain the right to “call” (repurchase) shares.
Preferred stocks, or “preferreds,” are a form of fixed-income security that trade like equities. They combine the dividend payouts of bonds and some of the appreciation potential of equities. As a result, they’re often attractive to investors who seek stable income over long-term growth.
Like bonds, preferreds issue at a “par value” and pay dividends on a set schedule. Dividend yields may be set as a percentage of the par value or fluctuate with a benchmark interest rate. (For instance, a $25 preferred with a 10% dividend would pay $2.50 annually.)
Preferred stocks can share other similarities with bonds, too, such as:
Preferreds also share a few features with company shares.
To start, preferreds trade on exchanges just like common stocks. Additionally, the par value may fluctuate in response to market pressures or business health.
Dividend payouts are also set by the board of directors, just like regular shares. But if the company can’t meet its dividend obligations, it may be able to postpone or skip paying out altogether, depending on the structure of the preferred equity.
And, like other types of stocks, preferreds rank below lenders, suppliers and bondholders for dividend and asset payouts.
Preferred stocks and common stocks have several important differences.
To start, while preferreds trade on exchanges, they’re less common than regular shares. As a result, they have a smaller market, which limits their liquidity. Additionally, while their share price can appreciate, they often have less long-term growth potential and may not produce capital gains.
Moreover, unlike common stockholders, preferred shareholders rarely receive voting rights. They may also have little to no say in corporate governance, policy or management decisions.
But preferred shares do have benefits over common stocks. For instance, they’re more likely to receive regular (and substantially higher) dividends. And during bankruptcies or liquidations, preferred shareholders are more likely to receive payouts than common shareholders because of the higher priority of preferred shares in the capital structure.
Generally, institutional investors are most likely to purchase preferred shares due to advantages that aren’t available to retail investors. Because these firms often buy in bulk, private or pre-public companies may issue preferreds to raise capital quickly. Companies may also issue preferreds to avoid taking on more debt.
Retail investors can also invest in preferred shares or preferred stock funds such as mutual funds or ETFs. That said, they’re not suitable for everyone, as they confer fewer rights and less long-term growth potential. Generally, preferred stocks stand to benefit investors with a shorter time horizon or low tolerance for market volatility.
Also, we advise any investor to carefully consider the specific structure of each preferred equity agreement. The terms for preferreds can vary substantially, which is an important consideration for potential preferred investors, as well as investors in the equity and debt of the company.
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