Preferred Stock Fundamentals
Before exploring the many types of preferred stock, it helps to understand what makes preferred stock unique: it is an equity security with bond-like characteristics.
What Preferred Stock Is
- Preferred stock is an equity security representing ownership in a corporation. It is NOT debt
- Pays a fixed dividend stated as either a percentage of par value or a flat dollar amount
- Par value is typically $100 per share (unlike common stock, which often has $1 par or no par value)
- Trades in the secondary market like common stock, but price behavior is more like bonds because it is interest-rate sensitive
- Because the dividend is fixed, preferred stock is classified as a fixed-income security despite being equity
Think of it this way: If you own a preferred stock paying $6/year and new preferred shares start paying $8/year, your $6 share becomes less attractive. Its price drops so the yield rises to compete. That is why preferred stock is interest-rate sensitive, just like bonds.
Example: A 6% preferred stock with $100 par pays $6.00 per year in dividends ($1.50 per quarter), regardless of how well or poorly the company performs.
Exam Tip: Gotchas
- Preferred stock pays a FIXED dividend. Do not confuse it with common stock dividends, which vary.
- Par value for preferred is typically $100, not $1,000 (that is bonds).
Preferred vs. Common Stock
Understanding how preferred stock differs from common stock is one of the most frequently tested areas.
| Feature | Preferred Stock | Common Stock |
|---|---|---|
| Dividends | Fixed rate, paid before common | Variable, declared by board |
| Voting rights | Generally none | Yes (statutory or cumulative) |
| Growth potential | Limited (trades near par) | Unlimited upside |
| Liquidation priority | Senior to common | Residual claim (last) |
| Price sensitivity | Interest rates (like bonds) | Earnings and market sentiment |
| Pre-emptive rights | No | Yes (right to maintain proportional ownership) |
Key distinctions:
- Preferred stockholders do not have pre-emptive rights; they cannot maintain their proportional ownership when new shares are issued
- Preferred stockholders generally cannot vote unless the issuer has missed a specified number of dividend payments (contingent voting rights)
- Preferred stock offers income stability but sacrifices growth potential. The fixed dividend is both its benefit and its limitation
Exam Tip: Gotchas
- Preferred stock is equity, not debt. Even though it behaves like a bond (fixed income, interest-rate sensitive, trades near par), preferred stockholders are owners, not creditors. In bankruptcy, preferred is paid AFTER all bondholders and creditors. This distinction is frequently tested.