GETTING TO KNOW
PREFERRED STOCKS

Are you interested in investing in preferred stock? Find out what sets it apart from common stock, the different types available, its pros and cons, and more.

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Once you start exploring the world of investing, you might come across the term “preferred stocks.” This does not mean the stocks people “prefer” to invest in. Instead, it’s one type of security that you can invest in.

But before you launch into investing in preferred stocks, it would be a good idea to get to know more about them, exploring questions such as:

• What are preferred stocks?
• Are there different types?
• What are the pros and cons of preferred stock investing?
• How do preferred stocks compare with common stocks?

This guide is a handy primer to get you started on your journey of learning more about preferred stocks.

What are preferred stocks?

Preferred stocks are a hybrid security — that is, they have features of both common stocks and corporate bonds.

According to Forbes, this combines the best of common stocks and bonds in one security. Like bonds, they pay dividends according to a set schedule, and like common stocks, they offer part ownership of a company.

Why do companies issue preferred stock?

Company owners might issue preferred stocks to entice early investors — since these securities don’t come with voting rights, the owners can maintain control of the business.

Another motivation to issue preferred stock is that, unlike issuing more shares, it doesn’t dilute the company’s share price.

Do preferred stocks pay dividends?

Yes, usually on a regular dividend schedule. Companies can postpone paying preferred dividends if they are unable to make a payment, but they must be repaid later.

Types of preferred stocks

There is a range of different kinds of preferred stocks, with availability varying between companies:

• Callable preferred shares. The company can choose to purchase these at a fixed future price.
• Convertible preferred shares. These can be exchanged for common shares at a fixed rate.
• Cumulative preferred shares. These offer protection against a downturn in company profits by requiring any unpaid dividends to be paid to preferred shareholders before common shareholders.
• Participatory preferred shares. These allow holders to share in dividends higher than the fixed rate when the company meets a predetermined profit target.

What are the advantages and disadvantages of preferred stocks?

Just like every other aspect of investing, there are advantages and disadvantages of preferred stocks. Some of these advantages and disadvantages include:

Preferred stocks vs common stocks

Both types of investment securities represent part ownership of a company. Beyond that, how would an investor compare the two?

Preferred stocks

Preferred stocks are like bonds in that they are issued at a par value. They can be redeemed later on when they reach maturity, and they pay regular dividends. But they are riskier investments than bonds because bondholders will be paid first in the event of a company failing.

Since they don’t confer voting rights, they are not of interest to shareholder activists. They are  attractive to risk-averse investors looking for safe, regular passive income who don’t want to buy and sell frequently.

Common stocks

Common stocks do grant owners voting rights. They offer unlimited potential in share price gains, but they also offer no protection from price falls to zero, which preferred stocks do.

Common stockholders are last in the queue after bondholders, and preferred stockholders are paid if the company fails and may receive no dividends. Common stock tends to be of more interest to long-term investors seeking share price growth over time.

How to buy preferred stocks

Companies issuing preferred stocks publish a prospectus outlining key features and risks. You can buy these stocks directly from the company or, after listing, through a broker.

The most common sectors issuing preferred stocks are utilities, real estate investment trusts (REITS), insurance, and banks.

Investors can buy individual stocks or a collection of preferred stocks through an exchange-traded fund (ETF).

For some, preferred stocks may be an attractive option, allowing them to purchase an early stake in a business and collect regular passive income. However, those seeking voting rights may be better off looking elsewhere for an asset that better suits their preferences. As with any form of investment, it is always a good idea to weigh up whether preferred stocks are suited to your risk tolerance and goals before investing.

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FAQs

Do preferred stocks have a maturity date?

Often, preferred stocks don’t have a maturity date and can continue perpetually. But most preferred stocks have a “call date” when the issuer may choose to redeem them at the par value.

Are preferred stocks safe?

On a risk spectrum, preferred stocks sit between bonds and common stocks — not as safe as bonds, but possibly safer than common stocks. However, as with any asset, it is important to conduct your own research to determine whether preferred stocks align with your investment goals.

Can you sell preferred stock?

Yes, you can buy and sell preferred stock on public and private stock markets.