Preferred Stock Definition

Preferred stock represents a type of ownership interest that usually entitles shareholders to receive fixed dividends before common stockholders, but typically lacks voting rights in the company.

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A preferred stock is also known as a hybrid security. This means that, while it’s considered an equity security, it includes features of both common stocks and bonds. Preferred stock is less risky than common stock but riskier than bonds.

How Preferred Stock Works

While preferred stock has the word “stock” in the name, don’t get preferred stocks confused with common stocks! In some ways, preferred stock benefits share more features with bonds than with common stocks. These include:

  • Paying out fixed dividends on a regular schedule
  • Responding to changes in interest rates
  • Having a “par value” preferred stock can be redeemed at, often set at $25 per share
  • Having the ability to be “called” by the issuer after a certain period, often five years

However, as we mentioned, there are some features of preferred stocks that look more like the business definition of common stocks. We’ll discuss some of those below.

Preferred Stock Advantages

Similar to common stock, preferred stock is a class of stock. However, preferred stock is granted certain rights that differ from common stock. Key differences include:

  • Preferred stock often has higher, guaranteed dividend payments no matter whether a company makes a profit
  • If a company doesn’t issue a dividend, sometimes the company has to pay back past dividends to preferred stockholders before it can make dividend payments to common stockholders
  • Preferred stockholders often have a higher claim to the company’s assets in the event the company goes out of business

As you can see, preferred stock can carry some serious advantages for preferred stockholders. Let’s review some other comparisons between preferred stock and other securities. As an investor, it’s important to take a hard look at these preferred stock benefits and understand the differences between these types of securities.

Preferred Stock vs. Other Securities

Preferred Stock vs. Common Stock

One of the biggest preferred stock disadvantages as compared to common stock is that preferred stockholders typically have no voting rights. Common stockholders almost always do. 

Preferred stockholders are also protected from the price volatility of common stock. This makes preferred stocks slightly more like a bond. Interest rate changes affect preferred stocks more than changes in the stock market.

Preferred Stock vs. Bonds

Legally, interest payments on bonds must be paid before any dividends on preferred or common stock. This means that even though preferred stocks are a less risky way to invest in a company, bonds remain the least risky way to invest in a public company.

Preferred Stock: Summary

  • Preferred stock has similarities to both bonds and common stock.
  • Preferred stockholders have a claim on a company’s dividends before common stockholders.
  • Preferred stockholders usually have no, or limited, voting rights.
  • In the event a company shuts down, preferred stockholders have a claim on a company’s assets before common stockholders but after bondholders.

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Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.

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Written by Team ZenBusiness

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