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What Are Preferred Stocks?
Preferred stock occupies a unique position in the capital structure between bonds and common stock. Preferred shareholders receive a fixed dividend that must be paid before any dividend is distributed to common stockholders. In bankruptcy, preferred holders have a higher claim on assets than common stockholders. In exchange for this safety, they give up voting rights and most upside if the company's stock rises significantly.
Preferred vs Common Stock
Common stockholders own a slice of the business with unlimited potential gain but are last in line in distress. Preferred stockholders get reliable fixed income with priority in the capital structure but almost no participation in the company's growth. Preferred prices are driven by yield, not earnings growth — they behave like bonds that happen to trade on a stock exchange.
Types of Preferred Stock
- Cumulative: missed dividends accumulate and must be paid before common stockholders receive anything
- Non-cumulative: missed dividends are gone permanently — more investor risk
- Convertible: can be exchanged for common stock at a set ratio
- Callable: company can redeem at a set price — typically when rates fall
Yield and Interest Rate Sensitivity
Preferred stocks are priced like bonds — yields rise when prices fall. When market interest rates rise, preferred prices fall. Typical yields range from 4–8%, higher than most investment-grade bonds because preferred ranks below bonds in the capital structure. This yield premium compensates for greater subordination risk.
Who Should Buy Preferred Stocks?
Preferred stocks suit income-focused investors seeking higher yield than Treasuries and corporate bonds who accept interest rate sensitivity. They are best held in tax-advantaged accounts. They are not a substitute for common stock in a growth-focused portfolio — they will not deliver equity-like capital appreciation over time.