If you follow financial news media, there is a good chance that you have seen announcements, press releases, or analysis related to preferred stock. What these reports are referring to is a class of equity securities that present a few aspects that set them apart from common stock. Shareholders who include preferred stock in their portfolios effectively own a fraction of the company, but the securities they hold are different from the common stock that may be issued by the very same company.
In the United States, the Securities and Exchange Commission exercise oversight over seven classes of company shares. Public shares authorized to trade in the open markets can be common or preferred. The vast majority of equity securities on Wall Street are of the common variety; some estimates suggest that up to 88% of shares can be classified as common stock. If a retail investor with a Fidelity trading account, for example, wants to go long on Microsoft shares, she would acquire common stock because the technology giant does not issue preferred stock at all. On the other hand, if the same investor is interested in Bank of America shares, she would be able to choose between common and preferred stock.
Preferred stock straddles the line between equity and debt securities. You could almost argue that preferred stock is like a corporate bond that is easier to trade. Many financial analysts and investment underwriters who work with S&P 500 companies will often tell their clients that issuing preferred stock looks better than floating bonds. This is a key difference because holders of common stock own pure equity in the company, but investors who hold preferred stock rarely think about themselves as being lenders.
The main selling point of preferred stock is that they feature fixed dividends, and they are supposed to be “hard dividends” just like bonds. Holders of common stock can also receive dividends if the company resolves to distribute profits among shareholders in that manner, but these will vary according to the performance of the company over designated periods. In the case of preferred stock, shareholders will know what is coming to them in advance. Conservative investors who follow strategies such as compound interest tend to be attracted to preferred stock for this reason; furthermore, the dividend yield may be even higher than common stock during some periods. There is also the matter of less volatility associated with preferred stock, which is why day traders tend to stay away from such shares.
Unlike common stock, however, preferred stock holders do not have voting rights. Institutional investors who intend to become majority shareholders with an eye towards being able to influence the executive board’s decisions in the future should stick to acquiring common stock. Finally, there is the matter of which shareholders would get first rights to claim the company’s assets in case of default. In case of an insolvency and bankruptcy court order, creditors and employees will get paid first, followed by holders of preferred stock and finally common shareholders. As you can see from these differences, preferred stock shares various features with corporate bonds, but they trade in more popular financial markets such as the New York Stock Exchange and the Nasdaq.