When people talk about stocks, they are usually referring to common stocks. To be precise, this is the most common form of stock offering.
Preferred stocks are a type of investment that offer a few key benefits when compared to common stocks. For one, preferred shareholders have priority over common shareholders when it comes to dividends and assets in the event of bankruptcy.
Here are some ways to know if you’re better off investing in preferred or common stock.
Dividends are payments made by a company to its shareholders, and they’re usually issued quarterly. Preferred shareholders are guaranteed to receive their dividends before common shareholders, which means they’re less likely to be affected by adverse economic conditions or company performance.
Also, when interest rates fall, dividend payments increase for preferred shares because investors see these shares as safe investments. As a result, investors will pay more for these shares. Here’s an example of a preferred stock offering highlighting how interest rates affect stock prices.
2. Voting Rights
Preferred stocks are a type of investment different from common stocks in a few key ways: voting rights. While holders of common stock typically have voting rights in the company, preferred stockholders don’t.
So when a company elects a board of directors or votes on corporate policy, preferred shareholders have no voice. Preferred stocks are similar to bonds since investors are guaranteed perpetual dividends with preferred shares.
3. Liquidation Preference
If a company is sold or goes bankrupt, the order in which shareholders are paid is called liquidation preference. Preferred stockholders are a priority for liquidation before any common shareholders are paid. Although common shareholders will also receive some portion of their investment, there is no guarantee.
One key difference is that preferred stocks are often convertible, meaning the holder can exchange them for a certain amount of common stock at any time. This can be beneficial if the company’s stock price rises, as holders can convert their preferred shares into a more significant number of common shares.
In contrast to common shares, preferred shares are also callable, meaning the issuer can redeem the shares after a set time.
Preferred shares offer investors the possibility of being redeemed at a significant premium over their purchase price if they buy them at a redemption rate. It is typical for the market for preferred shares to anticipate callbacks, and price increases may occur.
6. Calculating the Dividend Yield
The dividend yield of preferred stock is determined by dividing the dividend amount by the price of the stock. An offer of preferred stock is often based on the par value. This rate is usually calculated as a percentage of the current market price once the stock has begun trading.
In contrast, a common stock pays variable dividends determined by the board of directors and is never guaranteed. It is not uncommon for companies not to pay dividends to their common stock.
Conclusion: Which is Right for You?
Preferred and common stocks have different features, making them appealing to different investors.
Although they tend to have more complex characteristics than bonds, preferred stocks offer investors the chance to own a piece of a company’s equity while receiving a higher dividend.
So if you’re considering investing in a company whose stock you’re interested in, consider whether a share of preferred stock is right for you.