What are Preferred Stocks?
Preferred stock refers to stock that has any combination of features not owned by common stock, including properties of both a debt instrument and equity. It is generally viewed as a hybrid instrument.
Preferred stocks are higher in ranking compared to common stock, but subordinate to bonds with reference to claim. Besides, the terms of this form of stock are described in issuing the company’s articles of incorporation or articles of association.
Like bonds, preferred stocks are ranked by the main credit rating companies. This rating is generally lower as compared to that of bonds. Owing to the fact that preferred dividends do not possess the same guarantees as interest payments from bonds.
The key features associated with preferred stock are as follows:
- Higher dividends yields
- Convertibility to common stock
- Preference in assets, in case of liquidation
- Callability (ability to redeem before maturity)
- Preference in dividends
Types of Preferred Stock
- a) Straight or fixed-rate perpetual stock– has no maturity as the dividend rate is set for the life of the issue
- b) Convertible preferred stock- has a conversion price as its issuance with the aim of conversion to a company’s common stock at the set rate
- c) Participating preferred stock- entitles owners to dividend increases if, in a certain year, common stock dividends transcends preferred stock dividends
- d) Adjustable-rate preferred stock–is tied to treasury bills or other rates. The dividend is increased based on interest rates’ shifts, and determined by an established formula
Difference Between Preferred and Common Stock
Preferred stock and common stock are similar in a number of ways; both are sold and bought on the open market, both entitle the holder to a percentage ownership of the company and the process for acquiring both types of stock. Despite these similarities, the differences between each stock are as follows;
- Common stock refers to the type of stock ordinarily issues by a company to increase capital, carry voting rights, and indicate part ownership. Preferred stock refers to stock that gets priority regarding repayment of capital and payment of dividends.
- Common stock has relatively high growth potential, while the preferred stock has a slightly low propensity to grow.
- Preferred stakeholders have a guaranteed return at a fixed rate; on the contrary, common stakeholders return on capital is neither fixed nor guaranteed.
- The preferred stock holds preferential rights as the capital repayment and dividends, while common stock carries differential rights regarding repayment of capital, dividend, and voting.
- Common stock entitles a person to vote and participate in the company’s general meeting, while preferred stock denies one the opportunity to vote and participate in the said meetings.
- Common stock is unredeemable by a company, while preferred stock is redeemable, either when the company wants to buy back or on their maturity.
- Preferred stock can easily be converted into common debt or stock, whereas common stock cannot be converted into any other security.
How to Buy Preferred Stock
Step One: Make comparisons of preferred stock’s credit scores of various firms
Preferred stocks contain a credit rating, just like bonds, and investors are able to see before they settle on making a purchase. Notably, preferred stocks that have a higher rating in terms of credit will involve a lower risk as opposed to those that have lower ratings.
S&P Global provides a platform for you to verify your preferred stock’s credit rating. When you visit this site, set up an account, and search for a corporation. You can do this by clicking on ‘S&P Global Ratings,’ and then ‘Find a Rating.’
Step Two: Evaluate online brokerage companies and create an account
When buying preferred stock, similar to common stock, you are required to transact through a stockbroker. Many brokerage companies now conduct their operations online. Through these channels, traders can open their accounts with minimal trade and balance.
It is essential to assess the benefits and limits of diverse stockbrokers. Here are our top five best online stock brokers for this year.
Step Three: Determine the quantity of shares you want to buy
In order to ascertain that you are purchasing your desired stock at a low cost, track the stock for about seven days first.
Tip: Avoid the mistake that apprentices make when carrying out their initial trade (they buy in excess with an aim to reduce the impact of their broker’s cut).
Helpful hint: Be conservative. Begin with buying a few stocks and monitor their progress in the weeks that follow. In the event that the preferred stock radically decreases, the option to reverse your choice can be executed in an effortless manner.
Step Four: Ask for a buy using your broker’s trading platform
Once you have settled on the number of shares to purchase, place your requisition with the broker you chose. By and large, the details of conducting your trade are determined by the platform you use.
The following details need to be entered by a trader:
- The stock’s name
- Type of order
- Number of stocks to buy
After that, your broker will continue with the remaining process and soon enough (in your account), you can view your new stocks.
Step Five: Track the performance of your stock
In contrast to common stock, preferred stock is a more secure investment. Therefore, you are not required to evaluate its effectiveness on a daily basis. Nonetheless, it is fundamental to prioritize time to assess its performance at least on one occasion every year and readjust your portfolio to eliminate low-yielding assets.
Final tip: The symbols of preferred stock vary from that of common stock, so be certain that you have entered the right sign when you place your trade.
Many investors are not privy to the information that more than one kind of stock is available for purchase on the market. Preferred stock is a combination of bond and stock, and gives owners benefits as compared to an owner of common stock.
In order to make informed decisions on buying preferred stock, search for the most suitable stockbroker. Engage in effective strategies such as being conservative during your first trade and remember to keep an eye on the progress of your stocks.