Preferred Stock is a second type of stock which a company may like to issue. Preferred stock is enlisted separately from the common stock and it trades at a different price. It is an ownership in a corporation that has a higher priority on assets and earning than common stock. Preferred shares have dividends that should pay first before dividends to the common shareholders. Preferred shareholders enjoy a fixed dividend whereas common shareholders are not guaranteed a fixed dividend. When a company does well and their earnings increase then dividends of preferred shareholder also increase. There are many reasons for using preferred stock. Established companies use this stock to get additional debts. For the beginner company, preferred stock is used to attract more investment in order to grow the company itself.
Unique Characteristics of Preferred Stocks
There are many characteristics of preferred stock. Some of the unique characteristics are described here.
Dividend Payment Priority: It is the most attractive characteristic of preferred stock. Preferred shares pay dividends annually which is a fixed percentage of stock’s purchase price. Corporation has to pay to the preferred stockholders before anyone else. However, if the company does not have any earnings then it is not applicable to pay dividends to anyone.
Cumulative Dividend Payments: Preferred dividend payment can be either cumulative or non-cumulative system. This system should be considered in the beginning of investing in preferred stocks. The cumulative dividend payment is if a company fails to pay one year’s dividend to the preferred stockholders then the company should pay the dividends in the second year with adding the prior year.
Fixed Rate of Dividend: Preferred stock has a fixed rate of dividend. It is specified as a percentage of the par value.
Less Riskier than Common Stock: Preferred stocks are less risky than common stocks. In the case of bankruptcy or liquidation, companies pay preferred stockholders before the common stockholders.
Claims on Income and Assets: In the event of bankruptcy, preferred stockholders’ claims get priority over the common stockholders. Preferred stockholders can claim on income and assets of the company before anyone else.
Convertible Feature: Some preferred stocks issues have a convertible feature that allows preferred stockholders to exchange their preferred shares into common shares. The terms of a convertible feature are already set when preferred shares are being issued. In these terms, the conversion ratio and conversion prices are included. Conversion ratio includes the number of the common stocks the preferred stockholders will get for exchanging each preferred stock.
Callable Features: The issuer has the right to call in the shares at par value after a set date. The issuers tend to call when the interest rates have fallen. New preferred shares can be issued at a current lower price after excluding the old high rates.
Redeemable: some preferred stocks are redeemable by giving the right to the company to buy back them at a fixed date and price.
Preferred stock is also referred to hybrid security or ‘fixed-rate capital securities’ which was introduced in 1993. It is called hybrid security because preferred stock has similarities to both common stock and bonds. Preferred shares bear characteristics of both common stock and the debt represented by bonds. Common stocks are not paid regularly whereas preferred stocks are paid regularly. Again common stocks’ value is dependent on the growth rate of the dividends and preferred stocks’ value is fixed.
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