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What is Preferred Stock?

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The majority of the stock out there is common stock, but that’s not the only option when it comes to stocks. Like common stocks, preferred stocks can be bought on the stock market. However, there are a few important differences between them.

Dividend Priority

Preferred stock enjoys the benefits of a dividend, often with yields between 4% and 8%. Rather than interest rates, these yields are usually a set dollar amount per share. Most of these dividends are paid quarterly, giving investors a steady return on their investment. And while common stock can also have dividends, that “preferred” makes a big difference. As a holder of preferred stock, you are entitled to receive your dividends before dividends are dispersed to common stock. This is one reason for the preferred status.

Bankruptcy Priority

Ideally, you won’t buy stocks in a company that goes bankrupt, but it does happen. During the liquidation process, there’s a distinct pecking order for payments. Debt holders, including bondholders, are paid first. Then preferred stockholders are paid, and, finally, common stockholders. While this doesn’t guarantee that you will get your investment back, it does increase the chances.

The Middle Ground

Preferred stocks are a great investment for people who can’t decide between common stocks and bonds. Like bonds, preferred stocks give a fixed return on your investment. However, the dividend rate is usually more than the interest rate on bonds. Like common stocks, it’s easier to get into and out of preferred stocks, but they have the advantage of being steadier than the volatile common stocks.

Ratings

Many preferred stocks are rated by Standard & Poor’s or Moody’s. Issuers do have to pay in order to be considered, so not all preferred stocks will be rated, but it’s a good general guideline when looking at stocks. For S&P’s, ratings that are AAA, AA, A, or BBB are often safer. For Moody’s, it’s Aaa, Aa, A, and Baa. Make sure you do your own research, however, to make sure you know what you’re buying.

Downsides

A key trait of preferred stock is the inability to vote at shareholders meetings. With common stock, every share gets a vote, but not preferred stock. This is actually not that much of a disadvantage, since individual shareholders can rarely influence events in a company. That much sway is usually reserved for shareholders who have large percentages of the stock.

Additionally, preferred stock isn’t as affected as common stock by the earnings increases. High earnings might increase dividends on common stock, or increase the price, but preferred stock will have steady dividends and a steadier price.

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