Preferred stock (also called preferred shares, preference shares or simply preferreds) is a type of stock with features not possessed by common stock; including properties of both an equity and a debt instrument, and is generally considered a hybrid instrument. Owners of preferred stock are entitled to higher dividends compared to common stock holders, but usually have limited or no voting rights to influence corporate governance. Dividends paid to preferred stock holders at a fixed rate, a benchmark interest rate, or a distribution of company profits yielding monthly or quarterly.
Preferred stock vs. common stock
Preferred stocks are senior (i.e., higher ranking) to common stock, but subordinate to bonds in terms of claim (or rights to their share of the assets of the company) and may have priority over common stock (ordinary shares) in the payment of dividends and upon liquidation. Terms of the preferred stock are described in a companies articles of association.
Privileges of preferred stock
Preferred stock is often is issued to stakeholders in a company with privileges which make them unique compared to bonds and common stock.
Preferred stocks commonly do not have a fixed date of maturity or date of maturity, but can have features which allow them to be redeemed by a company under certain circumstances. Compared to bonds, for example, bonds are issued with a defined start and end period, and preferred stocks can remain outstanding indefinitely or until called by the company for repurchasing. The potential perpetuity of preferred stocks allow dividends to be paid to preferred stock holders indefinitely.
Dividend privileges of preferred stocks are what separates them most from bonds and common stock, and what makes them attractive to both the issuers and owners of preferred stock. A unique privilege of preferred stock is that dividend payments of preferred stock may be postponed, or skipped, by companies unable to make dividend payments to preferred stock holders.
Preferred stock dividends may also be cumulative or noncumulative. Cumulative preferred stocks allow companies to postpone dividend payments under certain company conditions but not skip them entirely. Noncumulative preferred stocks give companies the ability to completely skip dividend payments to preferred stock holders without being subject to any legal penalties.
Determining value of preferred stocks
The value of preferred stock is directly influenced by the agreed upon dividend payments structure and the discount rate set by the company issuing preferred stock. A simple formula for calculating the value of preferred stock—may not work in all cases because some preferred stock issuances may not fit the formula—can be found below:
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