Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Preferred Stock

What it is:

Like shares of common stock, shares of preferred stock represent an ownership stake in a company -- in other words, a claim on its assets and earnings. However, as the term suggests, "preferred" stock carries certain advantages. While preferred stock usually doesn't carry the same voting rights as common stock, it does have priority when it comes to dividends and bankruptcy. And like common stock, preferred stock can be bought and sold through a broker.

How it works (Example):

The primary difference between preferred stock and common stock relates to the order in which shareholders are paid in the event of bankruptcy or other corporate restructuring. If the issuing company seeks bankruptcy protection, then the owners of preferred shares take priority over common shareholders when it comes time to pay dividends and liquidate the company's assets.

The other main difference between preferred and common shares relates to dividends. Although dividends paid on common stock are not guaranteed and can fluctuate from quarter to quarter, preferred shareholders are usually guaranteed a fixed dividend paid on a regular basis. As a result, preferred stocks often act similar to bonds. The average dividend yield paid out on preferred stock has recently ranged from 5% to 7%. That compares to historical yields of around 6% for investment quality corporate bonds, and roughly 2% to 3% dividends for common stocks.

Why it Matters:

Preferred stock is a good alternative for risk-averse investors wanting to buy equities. In general, they are less volatile then common stock and provide a better stream of dividends. Most preferred shares are also callable, meaning the issuer can redeem the shares at any time, so they provide investors with more options than common shares. But for all of these advantages, preferred stock has one downside -- its shareholders generally do not enjoy the same voting privileges as the holders of common stock. Not all investors actively participate in voting, but it may be a deterent for some investors.

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