Preferred Stock

Definition

Preferred stock is a class of shares that give the holder a higher claim to dividends or asset distribution than common stockholders.

What Is Preferred Stock?

The term “stock” refers to ownership or equity in a firm. There are two types of equity: common stock and preferred stock. Preferred stockholders have a higher claim to dividends or asset distribution than common stockholders. The details of each preferred stock depend on the issue. 

Key Takeaways

• Preferred stock is a different type of equity that represents ownership of a company and the right to claim income from the company’s operations.
• Preferred stockholders have a higher claim on distributions (e.g., dividends) than common stockholders.
• Preferred stockholders usually have no or limited voting rights in corporate governance.1
• In the event of a liquidation, preferred stockholders’ claim on assets is greater than common stockholders but less than bondholders.2
• Preferred stock has characteristics of both bonds and common stock, which enhances its appeal to certain investors.

Understanding Preferred Stock

Preferred shareholders have priority over common stockholders when it comes to dividends, which generally yield more than common stock and can be paid monthly or quarterly.1

Investor.gov, U.S. Securities and Exchange Commission. “Stocks: What Kinds of Stocks Are There?”

 These dividends can be fixed or set in terms of a benchmark interest rate like the London Interbank Offered Rate (LIBOR)​, and are often quoted as a percentage in the issuing description.

Adjustable-rate shares specify certain factors that influence the dividend yield, and participating shares can pay additional dividends that are reckoned in terms of common stock dividends or the company’s profits. The decision to pay the dividend is at the discretion of a company’s board of directors.

Unlike common stockholders, preferred stockholders have limited rights, which usually does not include voting. Preferred stock combines features of debt, in that it pays fixed dividends, and equity, in that it has the potential to appreciate in price. This appeals to investors seeking stability in potential future cash flows.