What Is Preferred Stock And Who Should Buy It?
Preferred stock is a type of security or investment that has some of the attributes of equity and debt investments. The stock pays out a fixed dividend, has a par value and is a hybrid of both common stock equity and bonds. There are several types of preferred stock and different investors may be interested in different kinds. This article aims to outline the basics of preferred stock, who should consider investing in it, and the potential risks and rewards associated with it.
Understanding Preferred Stock
Preferred stock is a type of security that can be issued by a company. It consists of equity shares that are higher in seniority than common stock, meaning their dividends are paid before common stock dividends. Preferred stockholders don’t usually have the voting rights that a common stockholder does, either. Moreover, preferred stock dividends are usually paid at a fixed price and many issuers won’t pay dividends on common stock until the preferred stock dividends have been paid in full.
Types of Preferred Stock
There are various types of preferred stock that are available. These include:
• Callable Preferred Stock: Allows the issuer to offer more shares at any time and limit the transferability of the shares.
• Convertible Preferred Stock: Allowing the investor to convert the stock into a certain number of shares whenever they wish.
• Participating Preferred Stock: Offers higher dividends depending on the company’s profits.
• Fixed-rate Preferred Stock: Issued with fixed dividend payments and a set time frame.
• Zero-Coupon Preferred Stock: Issued at a discount with investors receiving the full face value at maturity.
Benefits of Investing in Preferred Stock
There are several advantages associated with investing in preferred stock. These include:
• Fixed Dividends: Most commonly, preferred stock investors receive fixed dividend payments. Generally, the higher the dividend rate, the higher the stock’s purchase price.
• Higher Yields: Preferred stock yields are usually higher than common stock dividends.
• Higher Seniority: Preferred stockholders have a higher seniority than common stockholders. They also receive independent of profits or losses a fixed dividend.
• Potential Tax Advantages: Qualifying preferred stock dividends are taxed at a lower rate than common stock dividends.
• Less Volatility: Preferred stock is typically less volatile than common stock.
• Potential Equity Position: Investors may be able to gain into a company’s equity via a convertible preferred stock purchase.
Who Should Consider Investing in Preferred Stock?
Depending on the type of preferred stock, different investors may be interested in investing in it. Here are some types of investors who should consider investing in preferred stock:
• Risk Averse Investors: Especially those looking for a higher, predictable return.
• Retired Persons: Investing in the long term (maturity of the stock) with a fixed dividend payment especially retirees.
• High-Net-Worth Individuals: Usually those looking for tax efficient investments.
• Dividend-Seeking Investors: Especially those interested in receiving a hefty dividend immediately.
Risks and Rewards Associated with Investing in Preferred Stock
Investing in preferred stock can be lucrative, but also comes with certain risks. These can include:
• Lost principal: Preferred stock holders may be exposed to a partial or full loss of their principal if the issuer is unable to pay off the debt.
• No voting rights: Preferred stock shareholders may not have any voting rights at the company’s AGM and any company related decisions may be taken without their consideration.
• No redemption: Preferred stockholders may have limited ability to sell their stocks due to the lack of liquidity in the secondary market.
• Interest rate risk: If the interest rates go down after investing in a preferred stock, the fixed dividend rate may become unattractive.
Despite the risks, the potential rewards of investing in preferred stocks can be quite high for the right investor. Preferred stocks usually provide a steady stream of income and when the stock price appreciates, a nice capital gain can also be realized. Moreover, several preferred stocks can come with a call feature, meaning the buyer can make a tidy profit if the issuer exercises the option to call the stock.
Investing in preferred stock may sound intimidating at first, however, with a little research and guidance, investors can make sound decisions. It is important to consider the various types of preferred stock and determine which is the right one for you. Also, remember to look into the potential returns and risks associated with the investment and understand that all investments come with certain risks.
Preferred stock is a form of security that behaves like both equity and bonds. Depending on the type of preferred stock, different investors may be interested in different kinds. The stock pays out a fixed dividend, has a par value and can be issued by a company. Generally, the higher the dividend rate, the higher the stock’s purchase price. Investors should be aware of the various risks associated with preferred stock investing and should consider taking advice from a qualified financial advisor before investing. Despite the possible risks, the potential rewards of investing in preferred stocks can be quite high for the right investor.
