When it comes to investing, the options you have available to you can be overwhelming. For numerous people, the stock market is too complex and risky, but other investment opportunities are available. One such option is the preferred stock which is a substantial part of the investing landscape.
Definition of preferred stock
Preferred stock is a type of security issued by a corporation and represent an ownership in the company. It is considered a hybrid of both equity and debt, as it can grant investors a return through dividends and capital appreciation.
Besides, preferred stockholders have preferential rights, meaning that they will receive preferential treatment regarding dividends, voting rights, and assets in the event of liquidation. Preferred stockholders are also given priority over common stockholders when it comes to payments of dividends, making them a more attractive investment for some.
Advantages of preferred stock
The two primary advantages of preferred stock are:
- Preferential dividend payments as preferred stockholders are entitled to receive dividends at a predetermined rate before common stockholders begin to receive payments.
- Lower risk as preferred stockholders are ahead of common stockholders in terms of asset claims in the event of liquidation. This results in less risk for preferred stockholders, making it an attractive choice for many investors.
Disadvantages of preferred stock
When it comes to investing in preferred stock, there are a few disadvantages to consider:
- Preferred stock usually doesn’t come with voting rights, so the investor has no say in how the company is managed.
- While dividends are usually paid out on the preferred stock, they are typically fixed, meaning they don’t fluctuate with the market.
- Preferred stock is generally less liquid than common stock, as they often don’t trade on the open market so it can be difficult to offload the stock if needed.
Types of preferred stock
- Participating preferred which provides both a fixed dividend and the right to share in any additional dividends declared.
- Convertible preferred which can be converted into common stock at certain times and a predetermined rate.
- Cumulative preferred which allows holders to accumulate and receive any unpaid dividends before common stockholders receive their dividends.
- Callable preferred which gives the company the option to repurchase the stock at a set price.
Preferred Stock vs. Common Stock
- The most basic form of equity typically makes most of a firm’s equity capital.
- More senior form of equity and more costly than Common shares.
- Have voting rights.
- No voting rights.
- No guarantee of dividend.
- Guaranteed a fixed dividend.
- Holds a residual claim on the business and therefore has the ultimate control of the company’s affairs.
- Have a higher claim on a company’s assets and earnings than common shareholders.
Level of priority in case of liquidation
- Last level of priority.
- Priority over common shareholders.
- More prone to dilution
- Anti-dilution rights
The Bottom Line
In conclusion, preferred stock is a great option for investors looking to receive regular income. It has the potential to offer higher returns than some other fixed-income investments due to its dividend payments and potential stock price appreciation. However, it is important to understand the specific terms and conditions of the preferred stock, as well as the risks associated with the investment, before investing.