What Is Preferred Stock? Definition, Advantages, Drawbacks

Preferred stock is a category of stock that comes with certain rights or features that are different than those granted to common stockholders. Unless there are special provisions, preferred stock prices are also like bonds in their sensitivity to interest rate changes. Although that flow isn’t contractually guaranteed the way it is with bonds, companies generally feel obligated to give precedence to paying preferred dividends over common dividends.

Most preference shares have a fixed dividend, while common stocks generally do not. Preferred stock shareholders also typically do not hold any voting rights, but common shareholders usually do. Because preferred stocks’ par values are fixed and do not change, preferred stock dividend yields are more static and less variable than common stock dividend yields. You calculate a preferred stock’s dividend yield by dividing the annual dividend payment by the par value.

What Are Preference Shares?

Also, if the issuer has additional optionality, they must pay the investors for it. The company might choose to do this if they decide the interest rates they’re required to pay are too burdensome. The call price, the call date, and the call premium, which is not always offered, are all clearly defined in the prospectus.

Investors often choose preferred stocks for their regular dividend payments. Since 1900, preferred stocks have seen average annual returns of over 7%, most of which are from dividend payments. However, it’s important to note that, even though preferred shareholders are paid dividends before common shareholders, dividends aren’t necessarily guaranteed.

  • The exchange may happen when the investor wants, regardless of the prices of either share.
  • If the issuers of the cumulative stock guaranteed dividends and miss a payout period, they are required to pay the cumulative amount they owe before giving common stock dividends.
  • If a company is not willing or able to pay a dividend for a preferred stock in a given quarter, though, you may be eligible for back payment.
  • Companies offering preferred stock include Bank of America (BAC), Georgia Power Company (GPJA) and MetLife (MET).
  • And like common stock, preferred shares represent a form of equity in the company.

Holders of preferred stock receive a dividend that differs based on any number of factors stipulated by the company at the issuer’s initial public offering. Preferred stock issues may also establish adjustable-rate dividends (also known as floating-rate dividends) to reduce the interest rate sensitivity and make them more competitive. The difference is that participatory shareholders may get more than the fixed dividends if the company has higher revenues than anticipated. Companies can use fixed amounts or percentages for calculating the additional earnings. The trade-off for the often substantially higher dividend yield received by preferred stockholders is the relative inability to actualize capital gains. Preferred stocks are called «preferred» because their dividends have to be paid before those that would go to the common stockholders.

Companies often offer preferred stock prior to offering common stock, when the company has not yet reached a level of success that would make it sufficiently attractive to large numbers of retail investors. 40+ printable petty cash log templates pdf word excel The sale of preferred stock then provides the company with the capital necessary for growth. Some advantages of holding preferred stock come to light most clearly when a business is in crisis.

This value is how much the issuer will pay back to the owner of the security when it is called or at maturity. Preferred stock is issued with a par value, often $25 per share, and dividends are then paid based on a percentage of that par. For example, if a preferred stock is issued with a par value of $25 and an 8 percent annual dividend, this means the dividend payment will be $2 per share. The features of preferred stock provide investors with certain benefits, but also come with caveats that potential buyers need to be aware of. Below is an overview of how preferred stocks work, and how investors can decide if it’s the right fit for their portfolio. While preferred stock shares some similarities with common stock and bonds, there are a few key differences as well.

Preferred stock is also called preferred shares, preferreds, or sometimes preference shares. Preferred stock performs differently from common stock, and investors should be aware of those differences before investing. The strategies that work best with common stock may not work with preferred stock, and vice versa. Unlike common stock, preferred stock comes with limited or no voting rights — you can’t use your share to vote for the board of directors, or for or against other policies. As with common stock, when you buy a share of preferred stock, you’re buying a small part of the company. And also like common stock, you usually get a certain percentage of money on a regular basis — that’s the dividend.

Dividends – cumulative vs. non-cumulative

The nature of preferred stock provides another motive for companies to issue it. With its regular fixed dividend, preferred stock resembles bonds with regular interest payments. However, unlike bonds that are classified as a debt liability, preferred stock is considered an equity asset.


They also have a lower rank than bonds in a company’s capital structure (more on that in the next section). If a share of preferred stock has a par value of $100 and pays annual dividends of $5 per share, the dividend yield would be 5%. All of the types of preferred stock are exactly that—preferred stock. Each may or may not have different features that make them more or less favorable compared to other types.

Preferred Stock Dividend Yields

This additional safety can lead to the market value of the preferred shares rising (which causes the yield to fall), but the movement is unlikely to match that of the common stock. Several additional provisions can affect the value of a preferred stock. These considerations include shareholder voting rights, the rate of interest, and whether or not the shares can be converted to common shares. So let’s say there’s a preferred stock with a $1,000 par value and the company that’s selling it offers a 5% dividend. That means you would receive $50 each year in dividend payments (most likely through quarterly payments of $12.50) for as long as you own the stock.

If you’re a preferred shareholder, you might have various reasons for doing this. However, the most common reason to exchange shares is if the common stocks are performing better. They love the higher dividends and are better equipped to assess the risks, including the fact that preferreds are less liquid (easily sold) than common stock. Institutions also get special tax advantages from preferreds in some cases.

Preferred shares come with high dividend payments but limited growth potential, and they might be called back by a company with little or no notice. While preferred shares offer more dividend security than common stocks, dividends still are not guaranteed. The conversion price per common share is thus $100, as the investor will receive 10 shares at $100 each. The decision about whether to convert will depend on where the common stock is trading at the time of conversion. A preferred stock is a share of a company just like a regular (or common) stock, but preferred stocks include some added protections for shareholders. For example, preferred stockholders get priority over common stockholders when it comes to dividend payments.


As implied by its name, the issuing company can call the share back (repurchase it) at a predetermined price. Generally, corporations issue callable stocks to avoid paying higher interest rates for extended periods. Each type is named for the action that the company takes for or against the share.

These materials were downloaded from PwC’s Viewpoint (viewpoint.pwc.com) under license. SmartVestor shows you up to five investing professionals in your area for free. Get stock recommendations, portfolio guidance, and more from The Motley Fool’s premium services.

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