Preferred Stock

Investment Dictionary -> Preferred Stock

What is a preferred stock?

Preferred stock or preferred shares refer to a category of ownership in a company that has a greater claim on the earnings and assets than common stock. Preferred stock dividends are usually paid out before distributing dividends to common stockholders. The specific details of the structure of preferred stock differ in each corporation. However, it is best to think of this as a financial instrument which combines in the traits of fixed dividends (debts) and equity which has the potential to appreciate.

What are the advantages of preferred stock over common stock?

• Preferred stockholders have a much higher claim to a corporation’s assets and earnings. Thus during favorable times, dividends are distributed to the preferred stockholders before common stockholders. During the times of bankruptcy, the company liquidates and pays all creditors and preferred stockholders, while the common stockholders are paid subsequently.

• The nature of the dividends of preferred stocks is different from those of common stock. The former is paid at certain regular intervals. When buying a preferred stock, you will get some idea when to anticipate a dividend. In case of a common stock, it is on the board of director’s discretion whether to pay out a dividend or not. Thus preferred stock usually is not fluctuating in nature as much as a company’s common stock. This is often referred to as a fixed-income security.

• The dividend right of a preferred stockholder is higher in the sense dividends can be accumulated. If the dividend is not paid in a particular year, it can be accumulated every year to be paid off cumulatively.

A small disadvantage with the preferred stockholders is that they usually have to give up their voting rights. Also, preferred stock or preferred shares have lower potential for appreciation.

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