Some corporations, particularly financial institutions and technology firms, issue preferred stock. Like common stock, preferred stock represents an ownership stake in a company. Preferred stock holders, like some common stock holders, receive dividend payments. Typically, the dividends on preferred stocks are fixed, which makes these securities particularly attractive to people seeking supplemental income.
Dividend payments to common stock holders are contingent upon a corporation's profits. If a firm makes money, it can share those profits with investors. Preferred stocks work differently, as the dividends are fixed. In most instances, the stockholders receive dividends for a period of at least 20 years. A company can stop paying preferred dividends if it actually lacks the funds to cover the cost. However, a company cannot pay one penny in the form of dividends to common stock holders until all of the preferred dividends have been paid.
Some investors view preferred stocks as a good alternative to bonds because both of the securities generate income -- although the yields on preferred stocks often exceed the yields paid on bonds. However, preferred stocks expose investors to a greater degree of risk than bonds because bondholders have priority in the event that a company goes bankrupt. Having settled any unpaid wages and taxes, the liquidators of a failed corporation must broker an agreement with the bondholders before preferred stock holders can make any claims on the company's assets. Common stock holders are the last in line to claim their share of the firm's assets.
Companies that issue preferred stock can run into financial difficulties if profits fail to meet expectations because preferred dividends can quickly erase earnings. Therefore, many firms only issue callable preferred stock. This means that the issuer can pay off the preferred stock holders before the maturity date. If a company calls in a preferred stock, stockholders only receive the call price, which is set when the company first issues the stock. Stockholders who purchased the stock above call price may lose a portion of their investment if the stock is called in.
Some companies issue preferred stocks that are convertible to common stocks. You may decide to convert if the preferred stock stops paying dividends or if yields on other securities rise and you find yourself unable to sell your stock on the open market. Preferred stocks share some of the hallmarks of both common stocks and bonds. Depending on the financial strength of the issuer and the state of the economy as a whole, those common characteristics can help or harm your investment portfolio.
- "Forbes"; The Case For Preferred Stocks; David K. Randall and Zack O'Malley Greenburg; November 2008
- Morning Star; Should You Consider High-Yielding Preferred Stock?; Timothy Stratus; July 2011
- "USA Today"; Preferred Stocks Provide Income but They are not Bonds; Matt Krantz; August 2007
- "Kiplinger"; Earn Dividends From Preferred Stocks; Jennifer Schonberger; April 2011
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