What Is a Characteristic of Preferred Stock?

Preferred stock represents a unique class of ownership, distinct from common stock. This equity security incorporates features appealing to investors seeking different financial outcomes. Understanding its characteristics is important for comprehending its role within a company’s capital structure. This article delves into its defining attributes and variations.

Fundamental Attributes

Preferred stock is characterized by specific features establishing its standing within a company’s equity hierarchy. A primary attribute is its provision for fixed dividend payments. These dividends, typically a percentage of the stock’s par value, offer a predictable income stream. For example, a preferred stock with a $100 par value and a 5% dividend rate would pay $5 annually, usually quarterly. These fixed dividends must be paid to preferred stockholders before any dividends are distributed to common stockholders.

In a company’s liquidation or bankruptcy, preferred stockholders hold a priority claim on the company’s assets. They are paid before common stockholders, though their claims are subordinate to creditors and bondholders. This preferential treatment provides a layer of security not afforded to common equity holders.

Preferred stock typically lacks voting rights, a key difference from common stock. Common stockholders generally possess voting rights, influencing corporate matters like electing board members or approving major decisions. Preferred stockholders usually do not have such privileges, though specific terms, including limited voting rights for extraordinary events, are detailed in the issuing company’s articles of incorporation.

Distinctive Features

Beyond fundamental attributes, various features shape preferred stock’s nature. One distinction is how dividends are handled if payments are missed, leading to cumulative or non-cumulative preferred stock. Cumulative preferred stock mandates that skipped dividend payments (arrearages) must be paid to preferred shareholders before any dividends are issued to common stockholders. Non-cumulative preferred stock does not accumulate missed dividends; if a payment is not made, the shareholder has no future claim.

A callable provision grants the issuing company the right to repurchase preferred shares at a specified price after a certain date. This call price is typically a premium above par value, with terms outlined in the stock’s prospectus. Companies may exercise this option if interest rates decline, allowing them to issue new preferred shares at a lower dividend rate and reduce their cost of capital.

Some preferred stock issues include a convertible feature, offering holders the option to exchange their preferred shares for a predetermined number of common shares. This allows investors to convert to common stock and potentially benefit from capital appreciation if the common stock’s market value increases. The conversion ratio, determining how many common shares one preferred share converts into, is set at issuance.

Participating preferred stock is a less common feature. This type allows holders to receive fixed dividend payments and, under certain conditions, an additional dividend beyond their stated rate. This additional dividend might be triggered if common stock dividends exceed a specified amount or if the company achieves predetermined financial goals. In liquidation, participating preferred stockholders may also receive their initial investment back, plus a pro-rata share of any remaining proceeds distributed to common stockholders.

Comparison with Common Stock

Preferred stock and common stock both represent ownership, yet they differ significantly. A primary difference lies in dividend payments: preferred stockholders receive fixed dividends paid before any distributions to common stockholders. Common stock dividends, conversely, are variable and not guaranteed, depending on company profitability and board decisions.

Another key distinction concerns voting rights. Common stockholders typically possess voting rights, enabling them to participate in corporate governance, such as electing board members. Preferred stockholders, however, generally do not have voting rights in routine corporate matters, though some preferred issues may grant limited voting power for extraordinary events.

In a company’s liquidation, preferred stockholders have a higher claim on assets than common stockholders. Preferred shareholders are paid out before common shareholders, but after creditors and bondholders. Common stockholders are last in line for asset distribution, receiving funds only if any remain after all other claims are settled.

Regarding price volatility and growth potential, preferred stock generally exhibits less price volatility than common stock due to its fixed dividend payments, making it more akin to a bond. Common stock, however, offers higher capital appreciation potential if the company performs well, as its value is more directly tied to growth prospects and earnings performance. Preferred stock’s value derives from consistent cash flow, whereas common stock’s appeal lies in long-term growth.