With the securities market often fluctuating, people are desirous of knowing about preferred stocks to determine whether they are making the right investment or not. They often throw questions at experts in the field asking them about the different stocks on the stock exchange and especially for them to give examples of preferred stocks on the market for sale.
Most people treat preferred stocks as equity securities. Others call them hybrid securities. Although preferred stocks differ in various ways to other securities on the market, still, they possess the same attributes as other debt instruments.
Similarities between bonds and preferred stocks
Preferred stocks carry a fixed par value attached to them. They are entitled to pay dividends in regards to the percentage at the rate that is fixed. Although the interest rate of the market value can change with preferred stocks and bonds, still, the owner of the securities is entitled to a fixed payment. Once interest rates increase, preferred stocks value will decrease to facilitate an improved rate for investors. When the rates lower, the stock value will increase.
An advantage that a preferred stock has is the long life span it possesses. This is because it does not carry a maturity date unlike bonds. However, the party that issues them can call them when a certain time is up.
Bonds and preferred stocks are superior to common stocks and hence people tend to invest in them more. While it is a fact that preferred stocks are less superior to bonds, they still hold a commanding attention from investors. People that invest in preferred stocks are given greater preference for receiving payments over those of common stocks.
After a company has issued bonds and preferred stocks to the public, they can later convert them to common stocks at their discretion. Once the preferred stocks are converted to common stocks, investors are given the privilege of partaking in the benefits that a common stock gives to them.
Major credit companies are given the privilege to rate bonds and preferred stocks. Since dividends from preferred stocks carry a lower guarantee of interest payable to bonds, the credit companies place them as subordinate to all creditors.
Differences between bonds and preferred stocks
One of the greatest differences to bonds and preferred stocks is that bonds are debt while a preferred stock is equity. The company that issues the preferred stocks will declare when dividends are supposed to be paid to owners of preferred stocks. However, whenever there is a cash flow problem affecting the company that issues the preferred stocks, that company directors have the legal right to withhold dividends.
Since bonds have a protecting indenture attached to it, the directors are not allowed to withhold any dividends from a bondholder. A second difference is that preferred stock holders are paid dividends from the company profits after tax is taken. With bonds, the company is required to pay dividends before taxes are taken out.
Different types of preferred stocks
There are a number of different types of preferred stocks available to investors. These are cumulative, callable, convertible, participating, and adjustable rate preferred stocks.
Cumulative preferred stock
Cumulative stocks are stocks that are paid later after a company has withheld part or all dividends pertaining to it. Such dividends are considered dividends in arrears and thus payment preference is given to owners of this type of stock above all other stocks. Some preferred stocks do not have a cumulative feature attached to it. This type of stock is called noncumulative or straight preferred stock.
Callable preferred stock
Callable preferred stock is redeemable, which gives the right to an issuing company to redeem it at a particular time and at a set price. These terms are usually set out in a prospectus.
Convertible preferred stock
With convertible preferred stock, a company can only convert based on terms set out in the stock’s prospectus.
Participating preferred stock
This type of preferred stock has a set fixed rate of dividend to be paid to investors and the terms are set out in the stock’s prospectus.
Adjustable rate preferred stock
Owners of adjustable rate preferred stock are required to collect dividends from their investment based on a number of factors specified by the issuing company’s directors. Adjustable preferred stock owners have some protection against contrary interest rates that sometimes affect a market.
Companies issue preferred stocks for two main reasons. The first one is that preferred stocks are flexible and dividends can be suspended whenever there is a cash flow problem. The second reason is that preferred stocks are much easier to market compared to others.
The pros of preferred stock
Still, there are some advantages and disadvantages to consider when one is dealing in preferred stocks. One such benefit is that preferred stocks carry a higher fixed income payment that those of bonds or common shares.
Disadvantages of preferred stocks are that they are given a lower investment rate in comparison to bonds. A preferred stock owner does not have any voting rights unlike bonds and common stocks. Then there is the problem of no maturity date that makes investors wary of investing their money in them.
With advantages and disadvantages presented to potential investors that are desirous of owning preferred stocks, it is no wonder that people investing their money in this type of security should be careful. However, people should not shy away from buying preferred stocks because of the drawbacks because there are some companies that pay big money to owners of such stocks. For those that are desirous of owning preferred stocks, they can consult the stock’s prospectus to ensure that they have all the information necessary.