What are Preferred Stocks?
Preferred stocks are a type of equity security that provides a fixed dividend payment before any dividends are paid to
common stockholders. They are often considered a hybrid between bonds and stocks due to their fixed-income component and potential for equity appreciation.
How Do Preferred Stocks Work?
Preferred stocks function by offering dividends that are typically higher than those of common stocks. These dividends are usually paid on a regular schedule and are prioritized over common stock dividends. If a company faces
financial difficulties, preferred stockholders have a higher claim on assets than common stockholders, but a lower claim than debt holders.
Why Do Companies Issue Preferred Stocks?
Companies issue preferred stocks to raise capital without compromising control, as preferred stockholders generally do not have
voting rights. It also provides a way to attract investors who seek reliable income streams with less risk compared to common stocks.
Fixed Dividends: Preferred stocks offer regular and often higher dividend payments.
Priority in Dividends: Preferred stockholders receive dividends before common stockholders.
Reduced Volatility: Preferred stocks tend to be less volatile than common stocks.
Convertible Feature: Some preferred stocks can be converted into common shares under certain conditions, offering potential for
capital appreciation.
Interest Rate Risk: Preferred stocks are sensitive to interest rate changes. When rates rise, preferred stock prices typically fall.
Credit Risk: If the issuing company faces financial trouble, preferred dividends may be suspended, and the stock may lose value.
Lack of Voting Rights: Preferred stockholders usually do not have any
say in corporate governance.
Callable Risk: Companies may have the option to buy back preferred stocks at a predetermined price, potentially limiting long-term gains for investors.
How Are Preferred Stocks Taxed?
Dividends from preferred stocks are generally taxed at a lower rate compared to ordinary income. However, the specifics can vary based on jurisdiction and individual tax circumstances. Investors should consult with a
tax advisor to understand the implications fully.
Examples of Preferred Stocks
Preferred stocks are issued by various types of companies, including utility companies, financial institutions, and large corporations. Some well-known examples include:Conclusion
Preferred stocks are an attractive investment option for those seeking regular income and reduced volatility. They offer a unique blend of features from both
equity and debt instruments. However, like any investment, they come with risks that investors must consider. Understanding these nuances can help in making informed investment decisions.