Preferred Stock Explained: 6 Types of Preferred Stock

Preferred stock is a share in a publicly-traded company that includes protections such as a guaranteed par value, reliable dividends, and special privileges in the case of liquidation. Like other types of stock, preferred stock offers investors proportional equity in a specific business, and you can buy and sell preferred stock on a public stock exchange. Unlike other types of stock, preferred stock does not come with company voting rights.

Comparing preferred stock to other investment products offers insight into how it operates.

• Steady dividends: Sometimes called preferred shares, preferred stocks operate like a hybrid of stocks and bonds. This means they usually come with fixed dividend payments and a predetermined redemption value. Most preferred stock will pay a fixed dividend at regular intervals.
• Claim to company assets: In the event of a company’s liquidation, preferred stockholders are paid out after the company’s bondholders but before common stockholders.
• Predictable growth: Compared to common stock, which comes with no guaranteed future value, preferred stock is more like a bond in that its issuer guarantees a par value at which it can be redeemed.
• Market volatility: Bonds mature at steady rates, but stocks rise and fall with market conditions and changes in interest rates. This is true of preferred stock, which will mirror the health of the general stock market.
• Callability: A company reserves the right to call back its preferred stock, or purchase it back from investors with interest. In this sense, it operates somewhat like a bond. But unlike a bond, there is no guarantee that company management will issue a call for preferred stock. This makes it possible to hold on to some preferred stock in perpetuity, as is the case with common stock.

There are many different types of preferred stocks available to shareholders.

1. 1. Cumulative preferred stocks: For such stocks, unpaid dividends accumulate for a future payment date, meaning a long-term investor is not punished when the company is in arrears.
2. 2. Non-cumulative preferred stocks: These stocks can skip a dividend without it accumulating for a future payment period.
3. 3. Participating preferred stocks: These stocks tie shareholder rewards to company performance. For example, if a company exceeds certain profit goals, shareholders may receive additional dividends.
4. 4. Convertible preferred stocks: These are preferred stocks that can be exchanged for a number of common shares in the same company. Such convertibility is only possible when a company issues both preferred stock and common stock.
5. 5. Callable preferred stocks: Stocks that can be called, or bought back, before they reach maturity are referred to as callable preferred stocks. This means the company is allowed to buy them back before they reach the advertised return price.
6. 6. Perpetual preferred stock: This type of stock has no fixed call date. In fact, a company may issue this preferred stock with no intention of calling it in. It effectively makes preference shares function far more like shares of common stock.

Common stock and preferred stock are two types of stock that both represent partial ownership in a public company. When you purchase shares of common or preferred stock, you effectively own a small portion of the company’s assets, which you can trade or sell at a later date. Despite similarities, there are key differences between the two.

• Availability: Companies are more likely to issue common stock than preferred stock. The most common sectors to issue preferred stock are insurance companies, utilities, financial institutions, and real estate investment trusts (REIT).
• Growth potential: Common stocks are subject to volatility and can experience significant fluctuations as the market price rises and falls. Preferred stocks usually come with a fixed-amount redemption value, meaning that stockholders won’t be able to sell their preferred stock above a predetermined figure, even if the price spikes.
• Stability: Since common stocks can experience significant value fluctuations, they run a higher risk of dropping to zero. Preferred stock dividends are a much slower and more stable investment since they experience much less dramatic swings and usually pay out a fixed dividend.
• Voting rights: Common shareholders can vote on parts of a company’s operations, including its board of directors, internal policies, and significant financial decisions. Preferred stockholders usually do not have voting rights, and their opinions do not factor into decisions surrounding company operations.

While preferred stock mimics many traits of bonds—and both may be attractive as fixed income securities—the two financial instruments are not the same.

• The ownership status is different. A bondholder is a debtholder; a stockholder is an equity investor.
• Bondholders get paid first. In the event of a company liquidation, bondholders must be paid off before stockholders can receive their money back. However, preferred stockholders get paid back before common stockholders do.
• Stocks are more volatile than bonds. Stock in well-managed companies tends to appreciate in value faster than bonds. However, stock is subject to market volatility and prices can collapse with little protection for investors. A good bond (particularly those issued by stable governments or large corporations) is guaranteed to appreciate over time, albeit at a fairly slow rate.
• Bondholders never have voting rights. Bondholders never receive voting rights when they invest in institutions. Common stockholders always have voting rights proportional to their ownership shares. Preferred stockholders fall in between; they rarely have voting rights, but some institutions do allow it.
• Preferred stock offers higher yields. Preferred stock shares tend to offer higher returns than most bonds. Many bondholders wait for a single payout at the bond's maturity date. With steady dividend payments at higher rates, preferred stock tends to offer greater short-term gains.

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