Preferred stock is a type of capital stock issued by a publicly traded company that provides a more secure dividend payment to investors than that of a regular stock. Preferred stock also usually carries voting rights with it, although they are generally more limited than those of a common stock. The primary benefit of owning preferred stock is the bond-like protection of dividends, although the ownership terms may vary from one company to the next.
Typically, preferred stock doesnt offer the stock-price appreciation that is common with common stocks. Still, because the dividend payments are, in effect, fixed payments, this type of stock can be attractive to income-oriented investors. Preferred stockholders can further benefit from a tax perspective. Dividends paid on preferred stock are generally considered qualified dividends by the Internal Revenue Service, meaning that rather than owing regular income tax on these payments, holders essentially owe the same 20% rate of long-term capital gains taxes.
Your ability to participate in a companys affairs and generate cash flow from dividends is dependent upon the type of stock you have. Whereas common stock represents the ownership of a company and generally has more voting power than preferred stock, preferred shareholders are essentially creditors of the corporation. This means that while they dont have the same voting power as the common stockholders, they are typically first in line to receive dividend payments.
The terms of preferred stock can also vary from company to company. For instance, many preferred stocks are cumulatively preferred, which means that if a company fails to make a dividend payment to preferred shareholders, that dividend is compounded and added to the next dividend payment. If a company fails to make dividend payments for multiple quarters, preferred shareholders can accumulate back payments up to the maximum share value of the stock issued.
In addition to the benefits mentioned above, companies generally issue preferred stock for two reasons. The first is to raise capital in a timely manner rather than through debt. The second reason is to strengthen the companys balance sheet by using preferred stock as a way to attract investors without taking on more debt or diluting the voting power of the common stockholders.
One downside to investing in preferred stock is that it can be more expensive to get rid of it than it is to exit a common stock position. Because preferred stock is typically less liquid than common stock, and the dividend payments may be fixed, exiting a preferred stock position can often require more patience than common stock.
In conclusion, while there are many benefits to owning preferred stock, it is important to be aware of the drawbacks as well. The right investment decision will depend on the preferences of the individual investor, as well as the specific financial situation of the issuing company. When examining which type of stock to invest in, investors should consider their own goals as well as the companys financial statements in order to make an informed decision.
