What are preferred stocks?
The definition says, preferred Stock (also known as preference shares) 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 be pay preferred stock before giving dividends to the common shareholders. The preferred shareholders enjoy a fixed dividend whereas common shareholders are not guaranteed a fixed dividend.
When a company performs well and its earnings increase then dividends for preferred shareholder also increase. There are many reasons for using preferred stock. An established company use this stock to get additional debts. For a new company, preferred stock is used to attract more investment in order to grow the company itself.
The post will gradually explain the types of preferred stocks, , hybrid security, and the key features or characteristics of preferred stocks.
Why Preferred stock is called a hybrid security as well?
By definition, a hybrid security is a type of security which has the combined features of equity and debt securities. So, the debt and equity characteristics are present in a hybrid security.
Preferred stock is said to be a hybrid security because it has combined characteristics of common stocks (equity securities) and bonds (debt securities).
Preferred stock is 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.
Bond features in debt stock: Preferred stocks offer a regular payment of a certain percentage of dividend which is actually a feature of a bond (debt instrument). Also, some preferred stocks can be converted in to common stocks.
Common stock features in Preferred stocks: in term of ownership, preferred stock represents a tiny portion of ownership in a company, like a common stock does.
How Many Types of Preferred Stocks are there?
There are mainly 4 types of preferred stocks that are used vastly by the corporations.
Cumulative preferred stocks: it’s a type of preference share that pays a certain amount of dividend at a regular interval. If the dividends at any point is not paid, it accumulates and must be paid in the next interval. The dividend must be paid before giving to the common stock holders.
Participating preferred stocks: sometimes, preferred stock holders are given dividends when a company performs well above the expected or certain goals are reached. Preferred stocks can be non-participating too.
Convertible preferred stock: like convertible bonds, some preferred stocks have convertibility features. So, the convertible preferred stocks can be converted to common stocks and cab be taken the advantages of price gain of common stocks. Preferred stocks can be non-convertible too.
Callable preferred stock: this mean the company can anytime call for the preferred stocks and buy back at a given future date. This can be an advantage for the company as the company can make a call when it’s suitable time.
Read: Characteristics of Common Stocks
Key Features or 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.
Advantages of Preferred Stocks for the Shareholders
Dividends: the dividend of the company is paid before paying the common stock holders. It ensures that the investment is less risky than investing in common stocks.
Higher Claim: the preferred stocks have a higher claim on the company’s asset. If the company goes for a bankruptcy, the preferred stock holders are paid first from the remaining assets.
Opportunities of Other Investments: some preferred stocks have the convertible features. It gives an investors to convert to common stocks which is an opportunity of price gain.
In Conclusion
Preferred stock is a different type of equity investment which is preferred by most types of investors all over the world. Because of its diversified features, investors are attracted to invest in the preferred stocks of a company. The post explained the key features or characteristics of preferred stocks.
REFERENCES:
- investopedia.com/terms/h/hybridfund.asp
- finance.zacks.com/preferred-stock-referred-hybrid-common-stock-debt-1540.html
- thefinancebase.com/characteristics-preferred-stock-5365.html
- financelearners.blogspot.com/2011/07/characteristics-of-preferred-stock.html
- mistakesintrading.com/wiki-stocks/characteristics-of-preferred-stock.php
- scottrade.com/knowledge-center/investment-education/investment-products/stocks/stock-basics/preferred-stock.html
- investopedia.com/walkthrough/corporate-finance/3/stock-valuation/preferred-stock.aspx
- investopedia.com/terms/p/preferredstock.asp
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Sadnan is one of the top contributors of The Strategy Watch, he has been actively contributing since 2017 as a Content Analyst; He has finished his graduation from North South University with a dual major in Accounting & Finance. As a contributor, he has written for different topics including Leadership Styles and Qualities, Finance, and Economics. He also has a strong interest in SWOT & PESTLE Analysis and Marketing Strategy.