What Is Preferred Stock?

Preferred stocks, also called preferred shares, are a type of investment security that has higher priority to common stock on asset claims of a company but lesser than bonds.

Preferred stocks typically do not carry any voting rights attached. However, the appeal for investors are the preferred stock dividends that are paid to shareholders and, usually, the right to convert preferred shares into common stock. 

Preferred stocks receive preference when a company pays dividends, Shareholders of preferred stocks also receive preference in a company’s assets in the event a liquidation sale.

Dividends of preferred shares may accumulate cumulatively or may be paid out to the investor within a specific time frame such as monthly,  quarterly, or Annually. 

Any dividends not claimed on a preferred stock by the investor at the time that they are paid out are lost. The type of preferred share that pays out dividends within a specific time frame is usually known as a non-cumulative or straight preferred stock. 

Preferred stock can be a useful addition to any portfolio. It is extremely suitable for investors whom are seeking safety of principal and dependable dividends. Some investors substitute a portion of their bond allocation for preferred stock as it generally pays a higher dividend. 

If you decide to purchase preferred stock it is recommend to seek a professional.

What are the Different Types of Preferred Stock?

There are many different types of preferred stock, and the characteristics of each issue are stated in a “Certificate of Designation.”  Here is some examples. Straight or Perpetual preferred stocks: They have no maturity date, they offer lifetime dividend payments. Term or Retractable preferred stocks: They have set maturity date, e.g. five years. Soft-retractable preferred stocks: Offer the issuer the power to cash (or to converted to equities) the stock after a specific date but with certain limitations.

One feature of Warren Buffet’s investment in Bank of America preferred stock that is considered advantageous is the cumulative nature of the preferred shares. Cumulative shares accrue a balance if a dividend is not paid. 

So if Bank of America were to miss a preferred dividend payment, then the company would be obligated to pay all past due dividends before paying any dividends to common stock shareholders. This stands in contrast to Bank of America’s common stock, which is non-cumulative. Non-cumulative common stock shareholders do not receive dividends if they are not authorized, and no balance accrues. Most, but not all, preferred stock is cumulative.

Preferred stock can also be callable — meaning that the issuer has the right to “call” your preferred shares at a certain price and retire the issue. 

Call provisions are often one of the main reasons that preferred stock can offer less potential for share price appreciation than common stock. Preferred issues may also contain provisions for converting preferred shares into shares of common stock.

Preferred stock can provide diversification benefits and unique risk/reward profiles when used properly. Keep in mind, however, that preferred stocks can be very complex securities.

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