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Below is a detailed and explanatory guide on preferred stock and all the information needed before making preferred stock investment decisions. Let us take a ride.
Prior to buying stocks, investors must understand the whole process of stock trading, be aware of different types of stocks and their features, as well as remember about associated pros and cons. Why are some stocks referred to as “preferred”? What is a preferred stock? What can it offer investors, and how safe is it to purchase such shares? This is a detailed and explanatory guide on preferred stock and all information needed before making preferred stock investment decisions. Let us take a ride.
Preferred stock is one of the top two types of stock that publicly traded companies issue to investors and represents a type of ownership in a company that an investor receives in exchange for buying the shares of the company. It accords shareholders ownership rights, including specified dividends. However, unlike common stock, which gives investors a vote for each share, preferred stock has no voting rights.
Almost anyone can buy the shares of a company as long as it is publicly traded. Offering preferred shares, companies raise capital in the primary or secondary market to settle debt, develop, invest in growth, and more.
There are a few characteristics that differentiate preferred stock from other types and make them unique:
Investors considering preferred shares also have to decide on the type of preferred shares to opt for. The types of preferred shares differ in features and the available benefits to holders.
The cost of preferred stock is calculated by dividing the annual preferred dividend payment by the stock’s market value per share.
Cost of Preferred Stock = (Preferred Stock Dividend Per Share (DPS) / Current Price of Preferred Stock)
While preferred stocks offer fixed dividends to holders, including priority payment over common stockholders, who also have ownership, bonds do not. Instead of ownership rights, bonds represent a loan from an investor to the bond issuer. Typically, the common issuers of bonds are companies or governments to generate funds.
Preferred stocks and bonds have some similarities to common stocks. Firstly, the two types have a fixed income value. Holders of either the preferred stocks or bonds are aware of the amount eligible to them per the amount of their investment, and this value is fixed with no flexibility. However, the dividend companies pay common stockholders varies, depending on the business’s financial performance.
More similarities between preferred stocks and bonds that distinguish them from common stocks are the callability features. They have a par value and can be fixed with a maturity date, usually lasting 30 years or more.
There are many advantages to investing in preferred stocks. Firstly, all investors want peace and assurance as their money is at stake, and preferred stocks offer some kind of assurance with their fixed return. Whether the company records losses or profits, preferred shareholders will receive their dividends as at when due, except on special occasions.
Secondly, preferred stocks come with priority. Although the return is fixed, the company may default in payment to pay later. In this case, preferred stockholders are prioritized and paid before common shareholders. As a matter of fact, if the company does not have enough money to pay all its investors, preferred stock owners are still considered first. The priority given to preferred stock is also effective in case of a company liquidation. These categories of investors are given precedence for payout.
Thirdly, preferred stocks’ callability leaves room for the possibility of the call price being higher than the initial price the investor paid to own the shares.
Further, there is less chance of fluctuation for preferred stocks.
Notably, it would be incomplete to talk about the benefits preferred stock offers, without mentioning its downside. Some of the cons of preferred stocks are the absence of voting rights, low growth potential, and low to moderate liquidity possibility.
Investing in preferred stocks requires going through a broker or brokerage firm. It is essential to research before taking this risky step and be convinced that preferred stocks are a choice. Many broker firms operate online and allow new signups with low minimum balances. However, workers differ according to the services they offer. Some charge high commissions that may not be the best for new investors.
It is often advisable to start with a few shares and keep an eagle eye on them before purchasing more. The specific processes of executing a trade depend on the platform.
To sum up, all investments are risks. Investment is not compulsory. Interested persons should decide to buy stocks of their own will, with full knowledge of the associated pros and cons. Preferred stocks are a good choice if you want to have a stable fixed income.
Preferred stocks are a type of stock with prioritized payment of dividends but no voting rights.
The key characteristics of preferred stocks include no voting rights, higher dividends, fixed returns, callable features, convertibility, priority, and more.
The types of preferred stocks are prior preferred, preference preferred, cumulative, noncumulative, convertible, perpetual, participating, and exchangeable.
While preferred stocks offer fixed returns but no voting rights, common stocks have voting rights with fluctuating dividends, and bonds provide no ownership rights.
Preferred stocks are reported in the shareholders’ equity section of a company’s balance.
The pros of investing in preferred stocks include fixed return, priority redeemable, and convertible, while some of the cons are no voting rights and lack of growth potential.
Investing in preferred stock requires dealing through a broker or brokerage firm.