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What are Preferred Stocks?

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  • Written By: John Lister
  • Edited By: Bronwyn Harris
  • Last Modified Date: 03 November 2016
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Preferred stocks is a name given to a special category of stock which has characteristics differentiating it from the general or "common" stock of the same company. This can include advantages such as being first in line to get dividend payments or having priority over claims if the company goes into liquidation. There are some disadvantages, most notably that preferred stocks do not usually come with voting rights.

The precise characteristics of preferred stocks vary from company to company. The most common is that anyone holding preferred stocks will be higher up in the pecking order if a company is liquidated and its assets divided among creditors. Depending on the rules of the stock, holders of preferred stocks will either get back the amount they invested or the market value of their stocks when the company was liquidated. As long as there is enough money left in the company, these holders will get this amount back as a flat amount. Holders of ordinary stocks will have to wait in line with other creditors and will usually only get a portion of the money they are "owed."

Another characteristic of preferred stocks is that holders normally get paid a fixed dividend. This dividend is paid before the dividend payments to holders of ordinary stocks. The payments to ordinary stocks will be determined on a year by year basis and is usually dependent on the company's performance and cash reserves.

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There is usually no guarantee that holders of preferred stocks will get a dividend payment. If they do, it must be paid at the agreed rate. This payment must be made before any dividend payment to other stockholders. The result of this is that it is impossible for a firm to make a dividend payment to ordinary stock holders without making one to preferred stock holders.

If a preferred stock is classed as cumulative, then whenever the company opts not to make a dividend payment, the amount it would have paid to preferred stock holders is carried over. For example, if the company makes no dividend payments whatsoever for two years, then in the third year it must pay preferred stock holders three years' worth of dividends before it is allowed to pay anything to holders of ordinary stocks. The alternative to this is known as non-cumulative. In this situation, if a company doesn't pay dividends one year, the holders of the preferred stock will never get any dividend for that year.

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NathanG
Post 3

@Mammmood - With preferred stocks dividends are paid out most of the time, even in bankruptcy, although there is no guarantee of that as the article points out. But dividends are another reason that you might want to jump into the preferred stock bandwagon.

When my dad was investing in the stock market back in his day, he would never invest in any company that didn’t pay dividends. But I guess that times have changed as everyone has looked for capital appreciation as the payoff rather than expecting some dividend payment.

To this day I have never owned a dividend paying stock but I can certainly understand its appeal to investors. If you have a boatload of preferred stocks in your portfolio, you can get a nice collection of dividend checks on a quarterly basis.

Mammmood
Post 2

@miriam98 - It’s not true. Individual investors can buy preferred stocks too. I’ve never done it but my understanding is that the return on preferred stocks is much better.

High yield preferred stocks might seem like a slam dunk to an individual investor, but there are precautions. For one thing, with that high yield comes less risk and volatility.

That may seem like a good thing but the returns can be similar to what you can get with a bond. So I wouldn’t go investing in preferred stock if you’re looking to make a quick buck.

It’s good for the long haul in my opinion. I’m sure you’re investment advisor can show you how to buy preferred stock if that’s something that you really want to do.

miriam98
Post 1

Clearly if you are an investor buying preferred stocks is much better than owning common stocks. I worked for a telecommunications company that went bankrupt, and during the liquidation process the preferred stock shareholders got first dibs, just like the article says.

Actually, I don’t think the common shareholders got anything, and this may have included employees of the company as well. I didn’t buy any stock as an employee but I did monitor the message boards, and it seemed that common shareholders got the short end of the stick.

Given that preferred stocks are such a better proposition, you’d wonder why everyone doesn’t own them. I got the impression that preferred stocks were mainly bought up by the financial institutions, to the exclusion of individual investors who could only own common stock, but I don’t know if that’s true.

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