Preferred stock

Definition

Preferred stock is a class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. It typically provides shareholders with fixed dividends and priority over common shareholders in the event of liquidation, making it an attractive option for investors seeking steady income and reduced risk.

5 Must Know Facts For Your Next Test

1. Preferred stockholders generally receive fixed dividends, which are paid out before any dividends are distributed to common stockholders.
2. In the case of liquidation, preferred stockholders are prioritized over common stockholders for asset distribution, but they stand behind debt holders.
3. Preferred stock can come with special features such as convertibility into common stock, callability by the issuing company, and cumulative dividends that accumulate if not paid out.
4. Preferred shares usually do not have voting rights, which means holders do not have a say in corporate governance compared to common shareholders.
5. Investors often consider preferred stock a hybrid security due to its combination of equity characteristics (like ownership) and fixed income characteristics (like bonds).

Review Questions

• How do the dividend payment structures differ between preferred stock and common stock?
  • Preferred stock typically offers fixed dividends that are paid out before any dividends to common stockholders. This means that if a company is distributing profits, preferred shareholders receive their set dividend first. In contrast, common stock dividends can vary based on company performance and may not be paid out at all if the company decides to reinvest profits or faces financial difficulties.
• Discuss the implications of liquidation preference for preferred stockholders compared to common stockholders during a company's bankruptcy.
  • During bankruptcy proceedings, preferred stockholders have a liquidation preference that allows them to be compensated from a company's remaining assets before common stockholders. This means that in the unfortunate event of liquidation, preferred shareholders will recover their investments first up to the value of their shares, while common shareholders may receive little or nothing depending on the remaining assets. This feature makes preferred stock less risky relative to common stock in such scenarios.
• Evaluate how the characteristics of preferred stock influence investment strategies and portfolio management for investors seeking income.
  • Preferred stock's fixed dividend payments and priority claim on assets make it an appealing investment for those looking for steady income with lower risk compared to common stocks. Investors seeking consistent cash flow often include preferred shares in their portfolios to balance risk while still participating in corporate growth. The ability of some preferred stocks to convert into common shares adds an element of potential appreciation, allowing investors to adjust their strategies based on market conditions and personal investment goals.

Related terms

Common Stock: Common stock represents ownership in a company and entitles shareholders to vote on corporate matters and receive dividends, but has lower claim on assets compared to preferred stock.

Dividends: Dividends are payments made by a corporation to its shareholders, typically from profits, and can be issued as cash or additional shares, with preferred shareholders usually receiving these payments before common shareholders.

Liquidation Preference: Liquidation preference is the order in which investors are paid back their investments in the event of a company's liquidation, where preferred stockholders receive payment before common stockholders.