What is Preferred Stock?
Preferred stock, also known as preference shares, is a class of ownership in a corporation that provides shareholders with a higher claim on assets and earnings than common stock. Preferred shares typically come with a fixed dividend, which must be paid out before any dividends can be distributed to common shareholders. Additionally, preferred stockholders usually do not have voting rights, unlike common stockholders.
Detailed Definition
Preferred stockholders enjoy certain protections and rights not available to common shareholders. For instance, in the event of a corporate liquidation, preferred stockholders are paid off before common stockholders but after debt holders. Preferred shares combine features of both equity and debt instruments, making them an attractive option for certain types of investors.
Characteristics of Preferred Stock:
- Dividend Priority: Fixed dividends that must be paid before common dividends.
- Liquidation Preference: Higher claim on assets in case of liquidation.
- Callable: Companies can repurchase these shares at a predefined price.
- Convertible: Some preferred stocks can be converted into a specified number of common shares.
- Non-Voting: Typically, preferred shares do not provide voting rights.
- Cumulative Dividends: Some preferred shares accumulate unpaid dividends, ensuring shareholders eventually receive due payments.
Examples
- Bank of America Preferred Stock: Offers fixed dividends, high liquidation priority but typically does not grant voting rights.
- Apple Inc. Convertible Preferred Stock: May be convertible into common shares under specific conditions, combining steady income with potential for equity growth.
- Ford Motor Company Series A Preferred Stock: Generally enjoys preference on fixed dividends and is callable at the company’s discretion.
Frequently Asked Questions
Q: What is the main advantage of preferred stock over common stock? A: The primary advantage is the fixed dividend and preferential treatment in terms of dividend payments and asset distribution in case of liquidation.
Q: Can preferred stockholders vote at shareholders’ meetings? A: Typically, preferred stock does not come with voting rights. However, there can be exceptions outlined in the terms of specific preferred stock issues.
Q: What is cumulative preferred stock? A: Cumulative preferred stock includes a provision that requires the company to pay preferred shareholders all dividends, including those that were missed in the past, before common shareholders receive their dividends.
Q: Are preferred stock dividends guaranteed? A: While preferred dividends have higher priority than common stock, they are not guaranteed and may be omitted if a company is in financial distress.
Q: Can preferred stock be converted into common stock? A: Yes, some preferred shares are convertible into a predetermined number of common shares, which provides more flexibility and potential upside for investors.
Related Terms
- Common Stock: Equity ownership in a corporation, providing voting rights but having the lowest priority in asset claims and dividends.
- Dividend: A distribution of a portion of a company’s earnings to shareholders, typically in the form of cash or additional shares.
- Liquidation: The process of bringing a business to an end and distributing its assets to claimants.
- Callable Stock: Stock that can be redeemed by the issuing company at a set price within a defined period.
Online References
Suggested Books for Further Studies
- “The Intelligent Investor” by Benjamin Graham - This classic book on investing provides insights into stock evaluation, including preferred shares.
- “Stocks for the Long Run” by Jeremy J. Siegel - A thorough examination of stock market history and key investment strategies, including preferred stocks.
- “Security Analysis” by Benjamin Graham and David Dodd - An in-depth guide to evaluating securities, including different classes of stock.
- “Preferred Stock Investing” by Doug K. Le Du - Specifically focused on strategies and tips for investing in preferred stocks.
Accounting Basics: “Preferred Stock” Fundamentals Quiz
Thank you for embarking on this journey through our comprehensive accounting lexicon and tackling our challenging sample exam quiz questions. Keep striving for excellence in your financial knowledge!