It’s a bit like being on the fast lane

You’ll get there, just a little bit faster. A preferred stock, just like a common stock, is a share of a company’s earnings and assets. The difference is that it holds a few extra benefits for the stockholders, such as getting paid dividends before common stockholders.

What is a preferred stock?

As the word suggests, a preferred stock is a stock which gives priority to its holders over common stockholders. Yet, unlike common stocks, people who own preferred stocks are a bit like women pre-suffrage. They do not have the right to vote for corporate’s decisions (although they may have special voting rights on other matters). The major ways in which it differs from common stock, is with regards to a shareholder’s dividends and right in the case of bankruptcy. Preferred stocks ensure a fixed dividend payout on a regular basis, and allow for its stockholders to be paid before common stockholders in case of restructuring of a corporation or liquidation after bankruptcy. Like bonds, preferred stock are sold at face value, or, as we say in finance language, par value. That being said, preferred stocks have more flexibility than bonds. Earned dividends can be deferred in the case a company cannot afford them in that specific moment, and can be paid off at a later date (whereas for bonds that’s a no-no and the company would risk bankruptcy).

perferred stock

Who prefers it?

Larger institutions are usually the ones who buy preferred stocks. Why? Mainly because of tax benefits, but also because this kind of stock can be good for risk-averse investors since they provide fixed, regular dividends, and are less volatile than common stocks. Companies, on the opposite end, often sell preferred stocks before common stocks because they might not feel ready for a large number of investors meddling in their decisions while still needing to raise larger sums of capital for growth.

Callable is a real word

Another perk of preferred stocks is that they are callable. This means that preferred stocks can be redeemed by the issuer at any time simply by paying the investors’ their money back. Just like bonds, preferred stocks are rated by credit agencies. Bonds are however a debt liability (aka: they equal debt, and no one likes to have debt), while preferred stocks are considered  an equity asset (aka: it is an investment from the owners ). This is obviously great news for a company, as they can raise cash without increasing their debt!

Why will your future self thank you?

Understanding the difference between common stock and preferred stock is crucial when starting to invest. While they both hold their advantages and disadvantages, it’s always good to know what benefits and rights a shareholder has over another. If you’d see someone jump in front of the queue without knowing that they have a priority pass, you’d be wondering why they get that privilege. It’s the same in the stock market - one needs to know the various roles, elements, and benefits in order to get the most out of it. Bits of Stock™ can help you with that while you start to invest!

Extra bits:

  • A stock certificate is what makes a stock yours. They used to be paper certificates you had to bring along when trading, but now they are just kept electronically.
  • 1 to 4: the ratio of women to men investing.
  • Think of preferred stocks as a “hybrid security”, having some elements of a common stock and others of a bond.