What is Preferred Stock?
Preferred stock is a breed of stock that gives investors a higher claim to payments from a company (aka dividends), but usually no voting rights.
Preferred stock is one of two main types of stock that gives investors first dibs on receiving income from the company, known as dividends, depending on how many shares the investor owns. Investors who own preferred shares are also usually paid before investors who own common shares if a company goes bankrupt (after creditors are paid), and sometimes have the option to convert their shares into common shares. Preferred shares don’t come with all of the perks though — they typically come with little to no voting rights, meaning these shareholders don’t get a say in decisions like selecting board members or other corporate events like mergers, acquisitions, or stock splits.
Let’s take a look at Ford’s stock as an example. As of January 31, 2019, 116,764 investors owned common stock in the company, and just three investors owned preferred stock. According to the company’s 2018 annual report, both preferred and common stockholders were paid a dividend of 15 cents per share for the fourth quarter of 2018. For the first quarter, both types of shareholders received 28 cents per share, while in the second and third quarters, both common and preferred shareholders received 15 cents per share. Source: Ford’s 2018 Annual Report.
Preferred stock is like a VIP pass at a concert, while common stock is like a ticket for general admission…
Both categories of stock are slices of ownership in a company, however preferred shares are a less prevalent type of stock and have characteristics of a bond. They give investors a prioritized spot in line to receive income from the company (aka dividends) before common stockholders. Preferred shares, however, usually come with little to no voting rights.
Common stock and preferred stock are the two main categories of stocks (which represent ownership or equity in a company). These two categories of stock are both purchased through brokerage firms, but they have some key differences:
It’s important to read the certificate of designation to know how a preferred share operates. Investors can look at the Securities and Exchange Commission’s public documents database called EDGAR to see what information companies issuing preferred shares have shared about their preferred stock, as well as other financial disclosures related to the stock.
Yes, a single stock can issue preferred stock in different classes. This means that a company could make different groups of preferred shares available with different dividend values. In preferred stock listings (places where investors can see which shares are available to buy), preferred shares will be listed based on their dividend yield, which is a ratio that shows the value of a dividend compared to a stock’s share price. For example, if a stock has a relatively low share price and a high dividend, it might have a high dividend yield relative to other stocks. Similarly, a stock with an average dividend and a high stock price might have a low dividend yield compared to other stocks.
Many preferred stocks are rated by agencies like Standard & Poor’s Corporation and Moody’s Investors Service. The ratings are typically meant to help disclose the creditworthiness of the issuer (in this case, the company making preferred shares available), as well as the company’s ability to pay interest it owes.
On a Standard & Poor’s rating scale, shares rated BBB or higher are usually considered to be investment grade (meaning the rating agency believes the issuer's prompt payment of interest and principal (at maturity) is considered relatively safe), while preferred shares rated below BBB- are considered to be higher risk than those rated higher.
On the Moody’s scale, preferred shares rated Baa3 and above are generally seen as investment grade, while stocks rated lower than Baa3 are usually considered to be below investment grade.
Keep in mind that credit ratings do not remove market risk and are subject to change.
Preferred shares tend to land in five different categories:
Companies issue preferred stock, or other securities such as common stock or bonds, as a way of raising capital to run their business or invest in new initiatives they think will drive future growth. Companies are sometimes attracted to issuing preferred shares over other types of securities for a few different reasons:
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