Nerdy takeaways
- Preferred stock has more protections for investors than common stock.
- Preferred stocks typically pay out fixed dividends on a regular schedule.
- Preferred stock is often considered less risky than common stock.
Investors who want to buy stock in a company may be able to choose between two main types of shares: common stock or preferred stock (aka "preferred shares" or "preferreds").
What is a preferred stock?
Preferred stock is a type of stock that has priority over common stock for distributions of dividends or assets in the event the company has to liquidate. Preferred stock is often perceived as less risky than common stock but riskier than bonds.
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How preferred stock works
In several ways, preferred stocks are similar to bonds.
- Preferred stocks typically pay dividends on a regular schedule, similar to how a bond makes coupon interest payments.
- Similar to bonds, the value of a preferred stock may fluctuate with changes in interest rates.
- Like bonds, preferred stock can be repurchased, or “called,” by the issuer after a certain period.
- Similar to bonds, preferred stock often doesn’t come with voting rights (common stock usually does).
That’s about where the similarities end, however. Preferreds have some quirks that separate them from bonds, making them attractive to investors.
- Bonds mature, but preferred stock typically does not. Unless the company repurchases the preferred shares, they can remain outstanding indefinitely.
- Preferred dividends can be postponed (and sometimes skipped entirely) without penalty. Companies make use of this unique feature if they’re unable to make a dividend payment. Cumulative preferred stock can postpone the dividend but not skip it entirely — the company must pay the dividend at a later date. Noncumulative preferred stocks may skip dividends completely without any legal penalty. However, this will make it difficult for the company to raise money in the future.
- Preferred stock can be convertible. This means the shareholder can exchange their shares for a specified number of shares of common stock at a specified price at some point in the future.
» MORE: How taxes on stocks work
🤓Nerdy Tip
The ticker symbols for preferred shares are different from their common stock counterparts. Make sure to verify all of the details to ensure you are purchasing the share class you want.Preferred stock vs. common stock vs. bonds
Preferred stocks can provide steady income via dividends but may have less upside potential compared to common stocks and may carry more risk than bonds.
Bonds: Bonds are typically a relatively less risky way to invest in a publicly traded company. Typically the issuer must make the required interest and principal payments on its bonds before it can pay any dividends on preferred or common stock. If the company were to liquidate, bondholders would have seniority over the preferred and common shareholders in terms of making a claim on whatever assets are left in the bankrupt company.
Preferred stock: Preferred stock is subordinate to bonds but senior to common stock. The issuer typically must make the required interest and principal payments on its bonds before it can pay the preferred holders.
Common stock: Common stockholders receive dividends only if the company declares a dividend and is able to pay its other bondholders and preferred shareholders. In the event of a company’s liquidation in bankruptcy, the common stockholders get what’s left after bondholders and preferred stockholders have been made whole.
Bonds | Preferred stock | Common stock | |
|---|---|---|---|
Ownership stake in company | Debt holder. | Equity owner. | Equity owner. |
Risk | Relatively less risk and price volatility. | Relatively medium risk and price volatility. | Relatively less risk and price volatility. |
Voting rights | None. | Typically none. | Proportional to ownership level. |
Distribution of assets (in bankruptcy) | Typically has a claim on assets that is senior to the stockholders. | Paid after bondholders but before common shareholders | Last if funds remain after paying bondholders and preferred holders |
How to buy preferred stock
Preferred stocks trade on exchanges similar to how common stock trades, which provides pricing transparency. However, most companies do not issue preferred stock, so the total market for preferred stock is relatively small and liquidity can be limited.
Common issuers of preferred stocks are banks, insurance companies, utilities and real estate investment trusts or REITs. Companies issuing preferreds may have more than one offering.
Before purchasing preferreds, an investor can review the rating from Moody’s or S&P for each particular offering and consider other features, such as yields, callability or convertibility.
As with other stock and bond investments, an investor can reduce risk by diversifying the preferred stocks in their portfolio. One way to do this is through an ETF or mutual fund, which allows you to buy a pool of preferred stocks and minimize the risk associated with just one offering.
