What is preferred stock?
Preferred stock A type of security issued by a corporation that gives its shareholders special financial rights over common stock. Holders of preferred stock often have priority in receiving dividends, getting their capital back before the company is liquidated, or other financial benefits. However, these rights come with some restrictions, the most common being limited or no voting rights in corporate management decisions.
Why do businesses issue preferred shares?
Companies issue preferred stock mainly for two purposes:
- Attracting large investors: Preferred stocks help businesses raise capital from institutional or individual investors who want stable returns instead of the risks of common stocks.
- Protecting management control: Since preferred stock may not have voting rights, founding shareholders can still maintain control of the company even if additional shares are issued.
Concept of preferred stock
Characteristics of preferred stock
Preferred stocks have distinct characteristics that distinguish them from common stocks. Here are some important ones:
Dividend priority
Preferred stockholders receive dividends before common stockholders, at a fixed rate or at an agreed rate. This gives investors a stable income, less affected by fluctuations in the company's profits.
For example, if a company makes a profit, preferred shareholders will be paid a fixed rate of dividend first, and then the remainder will be distributed to common shareholders.
Priority return
In the event of a company's liquidation or bankruptcy, preferred stockholders will be paid back before common stockholders. However, they still rank below creditors, bondholders (owners of bonds), and other financial obligations of the company.
Restricted voting rights
Most types of preferred stock do not have voting rights or only have voting rights in special circumstances, such as when the company changes its capital structure or changes the rights of preferred shareholders.
This helps the company's management maintain control, even when raising capital from large investors through preferred stock.
Low liquidity
Preferred stock is not as widely traded as common stock, so it is less liquid. This means that when investors want to sell their preferred stock, they may have difficulty finding a buyer, especially if the company is not listed on a stock exchange.
Convertible into common stock (depending on type)
Some preferred shares can be converted into common shares after a certain period of time or under certain conditions. This conversion usually comes with specific terms regarding the rate and timing of the exercise.
For example, a company might issue convertible preferred stock with the condition that each preferred share can be exchanged for 2 common shares after 5 years.
Learn the characteristics of preferred stock
What is dividend preferred stock?
Preferred stocks are stocks that give the owner a fixed dividend, even if the company makes no profits. They are a popular choice for investors who value stability and want a steady income from dividends.
Important features of dividend preferred stocks:
- Higher dividends than common stock: Preferred stock holders receive a higher dividend rate than common stock holders. This dividend can be paid in cash or stock, depending on the company's policy.
- Dividends can accumulate: Some types of dividend preference shares have a cumulative feature, meaning that if the company fails to pay a dividend in one financial year, it will be accumulated and paid in subsequent years when the company makes a profit.
For example, if a company commits to paying 8% in dividends each year but fails to do so for 2 consecutive years, then in the 3rd year when the company makes a profit, shareholders will receive 24% in dividends (8% x 3 years).
- No voting rights or limited voting rights: Holders of dividend preference shares usually do not have voting rights at general meetings of shareholders or have limited voting rights in certain special cases. This allows the company to raise capital without affecting the control of the board of directors and founding shareholders.
- High stability, suitable for investors who like safety: Dividend preferred stocks are suitable for investors who want a stable source of income without being too concerned about fluctuations in stock prices on the market. This type of stock is often favored by institutional investors, investment funds or retirees.
Important Features of Dividend Preferred Stocks
What is redeemable preferred stock?
Redeemable preference shares are shares that the issuing company has the right to buy back from shareholders at a pre-agreed time and price. This is a popular form of capital mobilization, giving businesses flexibility in their financial strategy, while also providing investors with a guaranteed return on investment.
Characteristics of redeemable preferred stock
- The company has the right to buy back shares: The biggest difference between redeemable preferred shares and other types of shares is that the company can buy back shares from shareholders at a certain time in the future, at a price agreed upon at the time of issuance.
- Unaffected by market fluctuations: The buyback value of the shares is predetermined, so shareholders are not affected by price fluctuations in the stock market. This brings stability to investors, helping them minimize risks.
- Can receive regular dividends: Similar to dividend preferred stocks, redeemable preferred stocks often come with a fixed dividend rate, providing investors with a steady source of income while holding the stock.
How to buy preferred stock?
Investors can purchase preferred shares through:
- Buy directly from the issuer.
- Buy on the stock exchange (if the stock is listed).
- Invest through investment funds specializing in preferred stocks.
Notes when buying preferred stocks
- Learn about the business and the conditions for issuing shares.
- Identify the type of stock that suits your investment goals.
- Monitor the market to choose the right time to buy.
Should you invest in preferred stocks?
Advantage
- Get higher, more stable dividends.
- Reduce risk when the company dissolves, shareholders have priority to receive capital first.
Disadvantages
- No voting rights or limited rights.
- Low liquidity, more difficult to trade than common stocks.
If you want steady income and are less concerned about controlling the company, preferred stock is a good choice.
Thus, the above article of LiveTrade Pro helped you understand What is preferred stock?? Preferred stock is an important financial tool, helping businesses mobilize capital effectively and bring stable benefits to investors. Depending on your investment goals, you can choose dividend preferred stock or redeemable preferred stock to diversify your investment portfolio.
