Different Types Of Preferred Stock With Definition
Types of preferred stocks article is a great source for stock traders to know the different types of stocks.
Moreover, when it comes to investment, stocks are a great way to earn high returns. The stock market is easily accessible and it is easy to invest in them.
Majority of the people think of common stocks when it comes to stock investment. However, there is another form of stock that is also issued by companies known as preferred stocks.
In this article, we will take a look at the different types of preferred stocks as each has different features and characteristics.
We will first get a quick understanding of what preferred stocks are before classifying its parts.
What Are Preferred Stocks?
Preferred stocks are a special type of stock that serves as investment security. Investors who own preferred stocks get fixed dividend payments after a certain time interval and this is the distinct feature of preferred stock that separates it from common stocks.
They are called preferred stocks because they are given preference over common stockholders when it comes to dividend payments.
Even in the case of liquidity and bankruptcy, preferred shareholders are paid first and if there is any dividend left, it is distributed to common shareholders.
Unlike common stockholders, they don’t enjoy any voting rights in the company. Thus, preferred stock can be thought of as a hybrid between a bond and common stock.
Features Of Preferred Stocks
Apart from the regular preferred stock that we discussed above, other types of preferred stock vary in features and characteristics.
Keep in mind that each type of preferred stock is different but they possess some common characteristics that are:
Dividend Payments Are Fixed:
No matter what kind of preferred stock you own, you get fixed dividends as payments. This doesn’t change no matter what kind of preferred stock you are trading
Preference Over Common Stockholders:
All 4 preferred stockholders get preference over common stockholders. Only after preferred stockholders are paid, common stock investors get paid.
Ownership Rights:
Like common stocks, preferred stockholders also own a portion of the company when they purchase preferred stocks.
All kinds of preferred stock owners are granted this ownership.
Types Of Preferred Stocks
We will discuss the diversity of the preferred stocks in this section. There are four types of preferred stocks that exist. They are:
Cumulative Preferred Stock
Cumulative stocks ensure that the shareholders are paid later if the current dividend is missed.
Say if dividend for one year is not paid to the shareholders, that payment is not forgotten and paid later when the company can do so.
Companies skip paying dividends due to a variety of reasons. They either have a debt to pay off, or pay bondholders first, or they simply want to invest in their company for further development.
Say if the company that issues cumulative stocks skips dividend payment for 3 years where the dividend payment each year was $50, then on the 4th year, $200 is paid as dividends.
Convertible Preferred Stock
These are preferred stocks can be converted to a pre-determined number of common stocks. At any point during their ownership of these stocks, they can choose to convert them into common stocks.
It doesn’t matter what the rate of the common stock is at that moment. The conversion rate is fixed before the purchase of convertible preferred stocks.
This is advantageous as the investor can convert his share to common stock when the value of the common stock exceeds the value of the convertible stock.
Once converted to common stock, the investor no longer gets the fixed dividend payment. The conversion process is also a one-time process. That means you cannot convert the common stock back to convertible preferred stock.
For example, if you buy 10 convertible preferred stocks at $10 each, your initial investment amounts to $100. Each of these preferred convertible stock can be converted to 10 common stocks.
You decide to convert them to common stock when the value of the common stock increases from $1 per share to $1.5. Thus your investment increases from $100 to $150.
Participatory Preferred Stock
Regular preferred stocks are guaranteed fixed dividends. However, participatory preferred stockholders get paid extra dividends apart from the fixed dividends.
This depends on the company’s certain financial goals and target. Companies set profit goals and if those are met, participatory stockholders are paid at a higher rate than the fixed dividend rate.
Companies issue participatory preferred stocks when it is unsure of the profits it will make. Even when the company faces a loss, the shareholders will get the fixed dividend payment.
Therefore, these stocks are better than regular preferred stocks. However, one thing to keep in mind is that the rate of dividend for these stocks is lesser than that of regular preferred stocks.
Considering all scenarios, by undertaking a little extra risk, participatory preferred stockholders enjoy a higher rate of return.
Callable Or Redeemable Preferred Stock
The other name of callable preferred stock is redeemable preferred stock. This is a type of preferred stock where the company that issues these stocks has the right but not the obligation to re-buy or redeem these stocks at a pre-defined price after a specific date.
This arrangement benefits the company more than the investor as they can control the supply of the stock in the market.
When the company issues these stocks, it sets the call price, the date at which it can be called, and the call premium.
This call premium is one of the reasons why investors are attracted to this stock type. It counters the risk that is posed when the shares are called early.
Just like other preferred stock types, they get preference over common stockholders when it comes to dividend payments and also in the event of a liquidation.
Callable preferred stocks can be convertible, cumulative, and participatory preferred stocks as well.
Adjustable-Rate Preferred Stock
Depending on the benchmark rate, the payout of dividend is modified. The modification happens every quarter.
The price of the share of particular securities may be less variable than a non-adjustable rate preferred stock.
Final Words
Preferred stocks offer fixed dividend payments to investors. Those looking for a steady and reliable source of return, preferred stocks are the way to go.
However, there are four different types of preferred types available: cumulative, convertible, participatory, and callable preferred stock.
Each of this preferred stock type varies in nature and we have described each of these in detail so you can choose which one will suit your investment style.
After reading this article, you should be able to understand and classify the different preferred stock types. The takeaway here is to invest wisely in the stock market no matter what stock type you are trading.
