1.3. Preferred Stock

Preferred stock, which, like common stock, represents an ownership share in a company, is an equity security that looks in many ways like a debt security (bond). Like a debt security, preferred shares generate income from a fixed, regular monetary payment rather than a share in the company’s financial gains. Also like a bond, a preferred stock’s market price fluctuates with interest rates and credit worthiness, rather than with a company’s earnings and losses. As a result, preferred stock is less risky than common stock, but it offers less growth potential. It is more risky than debt because companies can miss their regular dividend payments without being in default.

Preferred stock is “preferred” in the sense that dividend payments are distributed to preferred stockholders before any dividends are paid to common stockholders. Preferred stock also has a higher claim on a corporation’s dividends and residual assets during bankruptcy than common stock. If a company is forced to liquidate, preferred stockholders have first claim to its remaining assets compared to other equity holders. The price for these enhanced privileges is that preferred stocks generally come without voting rights and have no real share in the company’s profits.

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