Table Of Content
What Is Preferred Stock?
Preferred stock is a type of equity security that offers investors a hybrid between common stock and bonds. While it represents ownership in a company, preferred stockholders typically don't have voting rights.
Instead, they receive fixed dividend payments, which are often higher and more stable than those of common stockholders.
This makes preferred shares especially appealing to income-focused investors, such as retirees or conservative portfolio builders.
In the event of a bankruptcy, preferred shareholders are paid out before common shareholders—though still after bondholders.
Many large companies like Bank of America or Ford issue preferred stock to raise capital without diluting control among common shareholders.
Preferred Stock Characteristics
Preferred stock combines features of both equity and debt. Here are key characteristics that define how it behaves in a portfolio:
- Fixed Dividends: Preferred stock typically pays a fixed dividend, offering predictable income. For instance, if a preferred share offers a $2 annual dividend on a $25 share price, that's an 8% yield—appealing in low-interest environments.
- Priority Over Common Stock: In corporate earnings and liquidation, preferred shareholders are paid before common stockholders. For example, if a company is short on cash, it may suspend common dividends but still pay preferred ones.
- Callable or Convertible Features: Some preferred shares can be called (redeemed) by the issuer after a certain date or converted into common stock.
- Limited or No Voting Rights: Unlike common shareholders, preferred holders usually don’t vote on company matters.
These features make preferred stock a useful tool for diversifying income strategies or balancing risk in a mixed-asset portfolio.
Preferred Stock vs. Common Stock: Key Differences
Though both represent equity in a company, preferred and common stock differ significantly in terms of income, rights, and risk.
- Dividend Priority: Preferred stockholders receive dividends before common shareholders, often at a fixed rate. For example, utilities often issue preferred shares to guarantee regular income to investors.
- Voting Rights: Common shareholders typically have voting rights; preferred shareholders usually don’t. This allows companies to raise capital without giving up control.
- Price Stability: Preferred shares tend to trade in a narrow price range, behaving more like bonds. In contrast, common stocks can be more volatile, appealing to growth-focused investors.
- Claim on Assets: In bankruptcy, preferred shareholders are paid before common stockholders but after debt holders—providing a middle-ground level of protection.
Feature | Preferred Stock | Common Stock |
|---|---|---|
Dividend Payments | Fixed and prioritized | Variable and not guaranteed |
Voting Rights | Typically none | Usually included |
Price Volatility | Lower, bond-like behavior | Higher, market-driven |
Ownership Priority | Above common in liquidation | Last in payout hierarchy |
Conversion Option | Sometimes convertible | Not convertible |
Growth Potential | Limited capital appreciation | Higher long-term upside |
Why Some Companies Offer Preferred Stock Instead of Bonds
Companies may choose to issue preferred stock rather than bonds for greater financial flexibility and less restrictive obligations.
Preferred stock typically does not increase a company’s debt load, which can help maintain a healthier balance sheet and stronger credit rating.
For instance, a bank might issue preferred stock to comply with capital requirements without increasing its debt ratio.
Additionally, preferred dividends can be suspended without triggering default—unlike bond interest, which must be paid.
This feature became crucial during financial downturns, when firms like Citigroup paused dividends on preferred shares while avoiding default.
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Preferred Stock vs. Corporate Bonds: Key Differences
Feature | Preferred Stock | Corporate Bonds |
|---|---|---|
Ownership | Equity | Debt |
Dividend/Interest Type | Fixed dividend | Fixed interest |
Voting Rights | Rarely granted | None |
Bankruptcy Priority | After bonds | Higher than equity |
Tax Treatment | Not tax-deductible | Interest deductible |
Call/Convert Option | Often convertible | Often callable |
Are Preferred Stocks a Good Investment?
Preferred stocks can offer reliable income and reduced volatility, but they also come with trade-offs that may not suit every investor.
Pros | Cons |
|---|---|
Fixed, predictable income | Limited price upside |
Higher yield than common stock | Sensitive to interest rates |
Lower market volatility | Callable by issuer |
Potential tax advantages | Dividends can be suspended |
Priority in liquidation | May lack trading liquidity |
- Steady Income
Preferred shares typically pay fixed dividends, which can be appealing for retirees or anyone seeking consistent returns—like a utility investor earning 5–7% annually.
- Higher Yield Than Bonds or Common Stock
Many preferreds offer higher yields than the same company’s bonds or common stock, making them attractive during low interest rate periods.
- Lower Volatility
Because they trade more like bonds, preferred stocks tend to have more stable prices compared to common stock, which can swing with market sentiment.
- Tax-Advantaged Dividends
Qualified dividends from preferred shares may be taxed at lower rates than bond interest, depending on the issuer and investor's tax bracket.
- Priority in Liquidation
If a company fails, preferred shareholders are paid before common stockholders—offering a moderate level of protection.
- Limited Price Appreciation
Unlike common stocks, preferred shares have less upside potential, which may limit long-term capital gains.
- Interest Rate Sensitivity
When interest rates rise, the fixed dividend becomes less attractive, often pushing preferred share prices down—similar to bond price movement.
- Callable Risk
Many preferreds can be redeemed by the issuer at a set price, which might cut short your income stream if rates drop.
- Dividend Suspension Risk
Companies can suspend preferred dividends during financial distress—unlike bond interest, which must be paid or triggers default.
- Low Liquidity
Some preferred shares, especially those issued by smaller firms, can have low trading volume, making it harder to sell quickly.
How to Buy Preferred Stock Through a Brokerage Account
Buying preferred stock through an online brokerage is straightforward, but it’s essential to understand the type of share and its dividend structure first.
- Open or Log Into Your Brokerage Account: Use platforms like Interactive Brokers, Charles Schwab, or E*TRADE that offer access to preferred shares listed on major exchanges.
- Search for Preferred Stock by Ticker or Filter: Enter the company’s name or use filters like yield, call date, or sector. For example, “BAC-PL” refers to a Bank of America preferred share.
- Review the Share Details: Check dividend rate, credit rating, and call provisions. Some brokerages offer snapshot data or research tools for each preferred share.
- Place a Buy Order: Enter the number of shares and choose between market or limit order. Keep in mind that liquidity may be lower than with common stocks.
- Monitor for Calls or Suspensions: After making a purchase, keep an eye out for call notices or dividend changes. Some brokerages offer alerts or automated tracking for these events.
FAQ
Preferred stock is a type of equity that pays fixed dividends and has priority over common stock in earnings and liquidation. It blends features of stocks and bonds.
Preferred stock typically doesn't offer voting rights but provides fixed dividends and higher claim on assets. Common stockholders can vote but get dividends last.
Preferred stock suits income-focused investors seeking stable, predictable returns, such as retirees or those building conservative portfolios.
Some preferred shares are convertible, allowing holders to exchange them for a set number of common shares, especially in growth-focused companies.
No, but they are usually more stable. Companies can suspend them without default, unlike bond interest.
Preferred shareholders are paid before common shareholders but after bondholders during liquidation, offering moderate protection.
Generally, yes. Preferred stock is subordinate to bonds in liquidation and dividends can be suspended, but it often pays higher income.
Yes, many preferred stocks trade on public exchanges like the NYSE or Nasdaq, though some may be over-the-counter.
Yes, many are callable, meaning companies can buy them back at a set price after a certain date.
Financial institutions, utilities, and real estate investment trusts (REITs) frequently issue preferred stock for capital structure flexibility.
Some are qualified dividends and taxed at lower rates, depending on the issuer and investor’s tax situation.
