Macro Mondays: Preferred Stock

Welcome to the first installment of Macro Mondays in 2018! So, you may recall back in November we talked about the perks of owning "common stock" and what that generally means. Today we are going to take a look at its counterpart: preferred stock. How do the two differ, who buys preferred stock, and is there an advantage to owning one over the other? You're about to find out!

What is a 'Preferred Stock'?

A preferred stock is a class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. Preferred shares generally have a dividend that must be paid out before dividends to common shareholders, and the shares usually do not carry voting rights.

Preferred stock combines features of debt, in that it pays fixed dividends, and equity, in that it has the potential to appreciate in price. The details of each preferred stock depend on the issue.

How do preferred shareholders differ from common stockholders?

Preferred shareholders have priority over common stockholders when it comes to dividends, which generally yield more than common stock and can be paid monthly or quarterly. These dividends can be fixed or set in terms of a benchmark interest rate like the LIBOR​. Adjustable-rate shares specify certain factors that influence the dividend yield, and participating shares can pay additional dividends that are reckoned in terms of common stock dividends or the company's profits.

What happens when a company is in distress and considering bankruptcy?

If a company is struggling and has to suspend its dividend, preferred shareholders may have the right to receive payment in arrears before the dividend can be resumed for common shareholders. Shares that have this arrangement are known as cumulative. If a company has multiple simultaneous issues of preferred stock, these may in turn be ranked in terms of priority: the highest ranking is called prior, followed by first preference, second preference, etc.

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