1.4.  Preferred Stock

Preferred stock, like common stock, represents an ownership share in a company. But preferred stock is quite different from common stock. For instance, owners of preferred stock expect to earn income from a fixed, regular payment, rather than the chance to share in the company’s financial gains. Moreover, a preferred stock’s market price fluctuates with interest rates and creditworthiness, rather than with a company’s earnings and losses. As a result, preferred stock acts more like a debt security than an equity security.

Preferred stock is less risky than common stock, but it offers less growth potential. It is more risky than debt because companies can skip a dividend payment without being in default, as they would be if they skipped paying interest on a bond.

Preferred stock is “preferred” in the sense that dividend payments are distributed to preferred stockholders before any dividends are paid to common stockholders. Preferred stock also has a higher claim on a corporation’s dividends and assets during bankruptcy than common stock. If a company is forced to liquidate—that is, dissolve because of bankruptcy—after bondholders and other creditors, preferred stockholders have first claim to its remaining assets compared to other equity holders. The price for these enhanced privileges is that preferred stocks generally come without voting rights and have no opportunity to share in the company’s growth.