What Is Preferred Stock? Definition, Benefits, and Examples

This post may contain affiliate links. You can read the full affiliate disclosure here

A special kind of ownership in a business that blends aspects of debt and equity is preferred stock. Investors are often drawn to preferred stock for its stable dividends and priority over common stock in financial payouts. This article dives into what preferred stock is, its benefits, and examples of its use to help you decide if it’s a fit for your investment portfolio.

Understanding Preferred Stock: A Simple Definition

Preferred stock represents a type of equity that provides shareholders with specific rights and privileges over common stockholders. Unlike common stock, preferred stockholders typically receive fixed dividends and have priority in the distribution of assets if a company is liquidated. However, they often do not have voting rights in corporate decisions.

Types of Preferred Stock: Which One Fits Your Investment Goals?

Preferred stock comes in several variations, each tailored to different investor needs and risk appetites. By being aware of the many kinds of preferred stock, you may better match your investment with your financial objectives.

Cumulative Preferred Stock

Guarantees payment of missed dividends before common stockholders are paid.

Ideal for: Income-focused investors seeking stability.

Non-Cumulative Preferred Stock

Dividends are not accrued if missed, offering higher risk.

Ideal for: Confident investors relying on consistent payouts.

Convertible Preferred Stock

It can be converted into common shares, allowing capital appreciation.

Ideal for: Those seeking growth potential with a steady income.

Callable Preferred Stock

Issuers can repurchase shares at a set price after a specific date.

Ideal for: Investors seeking higher dividends despite repurchase risk.

Participating Preferred Stock

Offers fixed dividends plus additional earnings based on company profits.

Ideal for: Those who want steady income and profit-sharing.

Adjustable-Rate Preferred Stock (ARPS)

Dividends vary with interest rate benchmarks, hedging inflation.

Ideal for: Investors expecting rising interest rates.

Perpetual Preferred Stock

No maturity date; provides indefinite dividends.

Ideal for: Long-term investors prioritizing stable income.

Fixed-to-Floating Rate Preferred Stock

It starts with a fixed dividend and later shifts to a floating rate.

Ideal for: Those needing initial stability with future flexibility.

Key Takeaway: For the best investment outcome, choose a preferred stock type that matches your financial goals and risk tolerance.

Benefits of Investing in Preferred Stock

Preferred stock offers a range of benefits that make it attractive for certain types of investors. These benefits, which balance stability and prospective profits, make it a popular option for income-focused portfolios.

Regular and Predictable Income: Preferred stock provides consistent and often fixed dividend payments, making it a reliable source of income. This feature appeals to investors who prioritize steady cash flow, such as retirees.
Priority in Dividend Payments: Preferred stockholders are paid dividends before common stockholders. For cumulative preferred stock, any missed dividends must be paid before common shareholders receive theirs, providing an extra layer of income security.
Priority in Asset Liquidation: In the case of liquidation, preferred investors are entitled to a larger portion of the company’s assets than common stockholders. While they rank below bondholders, this added priority offers greater protection during financial instability.
Higher Dividend Yields: Preferred stock typically offers higher dividend yields compared to common stock or bonds. This makes it an appealing choice for income-oriented investors seeking better returns with moderate risk.
Lower Volatility: Preferred stock tends to exhibit less price volatility than common stock. Its value is more stable, offering investors a smoother experience, especially in uncertain market conditions.
Convertible Options for Growth Potential: Convertible preferred stock allows holders to exchange their shares for a predetermined number of common shares. This feature provides the opportunity for capital appreciation if the company’s stock performs well.
Tax Advantages: In some jurisdictions, dividends from preferred stock may qualify for lower tax rates compared to interest income from bonds. This tax treatment can enhance after-tax returns for investors in higher tax brackets.
Flexibility in Investment Options: Preferred stock comes in various forms, such as cumulative, non-cumulative, callable, and participating options. Because of this diversity, investors can select solutions that align with their financial goals and personal risk tolerance.

Key Takeaway: Preferred stock offers a combination of income stability, priority payouts, and potential growth through convertible options. Because of its unique benefits, it’s a fantastic choice for investors who wish to strike a balance between risk and return, particularly those seeking consistent income streams.

Risks and Limitations of Preferred Stock

While preferred stock offers many advantages, it has its risks and limitations. Understanding these potential drawbacks is crucial for making informed investment decisions.

Limited Growth Potential: Preferred stock does not typically benefit from the company’s growth in the same way that common stock does. While common shareholders can see substantial appreciation in stock value as the company grows, preferred stock prices remain relatively stable, focusing instead on fixed dividend payments.
Lack of Voting Rights: The majority of preferred investors cannot vote on corporate issues like choosing the board of directors or authorizing mergers and acquisitions. This limits their influence on the company’s strategic decisions, leaving those powers primarily in the hands of common shareholders.
Interest Rate Sensitivity: Preferred stock is highly sensitive to changes in interest rates. As interest rates rise, preferred stock’s set dividend payments lose appeal, which could result in a drop in the stock’s market value. Conversely, when rates fall, preferred stock may increase in value, though this is not guaranteed.
Credit Risk: If the issuing company experiences financial difficulties, it may suspend dividend payments on preferred stock. While cumulative preferred stockholders may eventually receive back payments, non-cumulative stockholders lose these dividends permanently. Additionally, in extreme cases, the company may default entirely, putting preferred stockholders at risk of losing their investment.
Callable Features: Certain preferred stocks are callable, which means that after a specific date, the issuing business may buy back the shares at a fixed price. If the company exercises this option, investors may lose a reliable income stream or be forced to reinvest at lower yields in a less favorable interest rate environment.
Market Liquidity: Because preferred stock is frequently less liquid than common stock, it may be more difficult to purchase or sell at the appropriate price. Higher transaction costs and greater bid-ask spreads may be the outcome of this lack of liquidity.
Dividend Suspension Risk: While dividends on preferred stock are generally more reliable than common stock, they are not guaranteed. Companies facing financial challenges may suspend dividend payments, especially for non-cumulative preferred stock.
Subordination in Bankruptcy: In the event of bankruptcy, preferred stockholders are paid after bondholders but before common stockholders. However, the recovery for preferred stockholders is not assured and often depends on the remaining assets of the company after fulfilling bondholder claims.
Inflation Risk: The fixed nature of preferred stock dividends makes them vulnerable to inflation. As the cost of living increases, the real value of fixed dividend payments diminishes, reducing the purchasing power of the income generated.

Key Takeaway: Preferred stock offers income stability and priority over common stock, but it comes with trade-offs, including limited growth potential, sensitivity to interest rates, and credit risks. Investors should carefully assess these risks relative to their financial goals and consider diversifying their portfolio to mitigate potential downsides.

Examples of Companies Offering Preferred Stock

Many well-established companies issue preferred stock as part of their capital structure. These companies often use preferred stock to attract investors looking for a steady income and relatively lower risk compared to common stock. Below is an overview of notable companies that offer preferred stock, along with key details.

Company Name	Preferred Stock Type	Dividend Yield	Notable Features	Ticker Symbol (if applicable)
Bank of America (BAC)	Cumulative Preferred Stock	5.5% – 6.5%	Reliable dividend payouts, strong financial stability	BAC.PR (varies by series)
AT&T (T)	Perpetual and Callable Preferred	5.0% – 6.0%	Attractive dividend rates, widely held by income investors	T.PRA, T.PRB
Procter & Gamble (PG)	Non-Cumulative Preferred Stock	4.5% – 5.5%	A strong global brand with consistent earnings	PG.PRA
Wells Fargo (WFC)	Cumulative and Non-Cumulative	5.5% – 6.7%	Multiple series available, solid financial performance	WFC.PR (varies by series)
Ford Motor Company (F)	Convertible Preferred Stock	6.0% – 7.0%	Convertible option linked to common stock growth	F.PRA
General Electric (GE)	Perpetual Preferred Stock	5.0% – 6.2%	Long-standing industrial giant with stable dividends	GE.PRA
Pfizer (PFE)	Adjustable-Rate Preferred Stock	3.5% – 5.0%	Dividend adjusts with interest rate benchmarks	PFE.PRA

Highlights of Notable Companies

Bank of America (BAC): Known for its financial strength, Bank of America offers multiple series of cumulative preferred stock. These shares are popular among income-focused investors due to their consistent dividend payouts and competitive yields.
AT&T (T): AT&T issues perpetual and callable preferred shares, appealing to investors who value steady income from a blue-chip telecom company. The callable feature means the company can redeem the shares after a specified date, typically at a premium.
Procter & Gamble (PG): A global consumer goods leader, Procter & Gamble’s non-cumulative preferred stock is backed by its stable revenue streams and robust market presence.
Ford Motor Company (F): Ford’s convertible preferred stock is a popular option for investors looking for income now and potential growth if the company’s common stock appreciates.
Pfizer (PFE): As a pharmaceutical giant, Pfizer offers adjustable-rate preferred stock that protects investors against inflation by adjusting dividends based on prevailing interest rates.

Key Takeaway: Preferred stock from large, established companies provides a blend of income stability and reliability. Cumulative, perpetual, and convertible preferred stocks are among the options available to investors, depending on their financial goals and risk tolerance. The table above offers a snapshot of some of the most attractive preferred stock offerings currently available.

Conclusion

Preferred stock provides a balance of income and stability, making it an excellent option for investors who prioritize fixed returns over growth. While it comes with certain risks and limitations, understanding its features and types can help you leverage its potential benefits effectively. Explore your investment goals and consider adding preferred stock to your portfolio.

FAQs

What is the main difference between preferred and common stock?

Preferred stock offers fixed dividends and priority in payouts but lacks voting rights, while common stock provides voting rights and higher growth potential.

Can I lose money investing in preferred stock?

Yes, preferred stock can lose value due to interest rate changes, credit risk, or company financial issues.

Are dividends from preferred stock guaranteed?

Dividends are more consistent than common stock but not guaranteed, especially for non-cumulative preferred stock.

Is preferred stock better than bonds?

Preferred stock offers higher returns than bonds but comes with higher risk and no guaranteed principal repayment.

How do I buy preferred stock?

You can purchase preferred stock through a brokerage account, similar to common stock or bonds.