Glossary
Preferred stock
A class of shares that pays a set dividend ahead of common stock and ranks above it in liquidation, usually without voting rights.
On this page
Preferred stock is a class of company shares that sits between bonds and common stock. Holders are promised a fixed dividend that must be paid before any dividend goes to common shareholders, and they rank ahead of common holders if the company is liquidated. In exchange they usually give up voting rights and most of the upside if the business does well. Banks, insurers, utilities and REITs are the most frequent issuers.
How it works
A preferred share has a par value, often $25 for shares sold to individual investors, and a stated dividend rate on that par. The rate can be fixed, floating, or fixed for a period and then reset.
Key features to look for in the prospectus:
- Cumulative or not. If a cumulative preferred dividend is skipped, it accrues and must be paid before common dividends resume. Non-cumulative dividends that are skipped are simply lost.
- Call date. Most issues let the company redeem them at par after a set date, often five years after issue. That caps the price: few buyers will pay much above $25 for a share that can be called at $25.
- Convertibility. Some preferreds can be exchanged for common stock at a fixed ratio.
How it behaves
Because the payout is fixed, preferred prices move mostly with interest rates and the issuer's credit quality, much like a long-dated bond. Yet preferreds rank below every bond in the capital structure, so in a bankruptcy they are paid only after creditors. Dividends can also be suspended without triggering a default, unlike bond interest.
That mix of equity-like risk and bond-like upside is the main trade-off. Tax treatment varies too: many preferred dividends are taxed as qualified dividends, but some hybrid structures pay interest taxed as ordinary income.