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Preferred Stock

Preferred stock is a hybrid financial instrument, with both equity and debt features. Preferred stock normally pays a high dividend rate, making it a popular investment for the income orientated investors looking for high yields. It’s also a favorite marketable security held by corporations and LLC organizations, because of its 85% corporate income tax exclusion. Preferreds are susceptible to inflation and rising interest rate risk. They have the pricing characteristics of a bond, but are subordinated to all the creditors in case of liquidation; their yields, moreover, are higher then senior debt due to their subordinated position. Preferred shareholders are paid ahead of the common shareholders, and normally have no (or very limited) voting rights. Most preferred issues have call provisions; beginning 5 years from date of issuance. It is an expensive security for the issuing corporation, because dividends paid are not deductible for tax purposes, versus bond interest, which is deductible.

There are four main types of preferred stock:

  • Straight non-cumulative preferred: Fixed rate dividend with no maturity date. Dividends do not increase over time. Holders have no claim on suspended dividends.
  • Cumulative preferred: Dividends accrue, even if not paid. Owners are entitled to all past unpaid dividends before common shareholders are paid.
  • Participating preferred: Shareholders may participate in the earnings of the company beyond their stated dividend rate, if certain earnings hurdle levels are met. Most preferred shares are non-participating.
  • Convertible preferred Exchangeable into a certain number of common shares. The holder receives a dividend paying instrument, combined with some of the upside appreciation
    potential of the common stock.

Preferred stocks avail young adults the opportunity of a cash dividend, usually paying a higher interest rate than debt instruments. Additionally, with convertible preferred, the holder may participate in both a cash dividend and in the price appreciation of the stock


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