INTRODUCTION TO PREFERRED STOCKS

What Are Preferred Stocks?

A preferred stock is a hybrid security, blending characteristics of both stocks and bonds. Like common stocks, preferreds represent ownership in a company and are listed as equity in a company's balance sheet. However, certain characteristics differentiate preferreds from common equity. First, preferreds provide income to investors in the form of dividend payments and typically have higher yields than common stocks. Preferred shareholders have seniority in a company's capital structure and have a higher claim to company assets in the situation of company liquidation (see Exhibit 1). Preferred shareholders are not privileged to vote on corporate matters, thus having less influence on corporate policy. While common shares offer investors the potential for share price and dividend increases, investors generally look to preferred securities for their high-yielding, stable dividend payments.

Similar to bonds, preferreds are issued at a fixed par value, with most preferreds paying scheduled, fixed dividends. Many preferred securities are rated by independent credit rating agencies with the rating generally lower than bonds since preferreds offer fewer guarantees and claims on assets. While a company risks defaulting if it misses a bond interest payment, it can withhold a preferred dividend payment without facing default risk.