Preferred Stock

Preferred stock is a type of equity that typically pays fixed dividends and has priority over common stock in the event of a liquidation.

In short, they sit in between common stock and bonds in the capital structure of a company. Most companies don’t issue preferred shares, but some do.

In terms of discussions on capital markets, preferred shares receive little attention, which is perhaps a little unfair.

They yield more than traditional bonds and have greater price stability than stocks – though are expected to yield less than stocks over long time horizons.

So, from this angle, their role in portfolios is ambiguous due to their hybrid characteristics. We’ll cover correlations with other major asset classes later in the article.

Key Takeaways – Preferred Stock

• Preferred stock sits between bonds and common stock in the capital structure. It blends income with lower volatility than equities.
• The asset class typically pays fixed dividends.
• It also has priority over common stock in dividends and liquidation.
• Yields are often higher than bonds.
  • But long-term upside is usually less than common stock.
• Prices are driven more by interest rates than company growth, which can limit capital appreciation.
• Key variants: cumulative (missed dividends accrue), perpetual (no maturity), and convertible (equity upside optionality).
• Downsides include limited voting rights, call risk, and lower liquidity than common shares.
• Best suited for those looking for income, stability, and diversification beyond bonds.
• ETFs (e.g., PFF, SPFF, VRP, PGX) offer easy access and monthly income, which can reduce single-issuer risk.
• As a portfolio diversifier, their hybrid nature means relatively high (+0.60) correlation with equities.
  • While there’s some diversification value, it’s mostly viewed as an income-focused equity sleeve, rather than something closer to a fixed-income/bond security.

Preferred Stock vs Common Stock – Key Differences

Preferred Stock

1. Pays fixed dividends

2. Has priority over common stock in the event of a liquidation

3. Senior in the capital structure to common shareholders

4. May be redeemed

5. Voting rights are limited or non-existent

Common Stock

1. Pays variable dividends

2. Does not have priority over preferred stock in the event of a liquidation

3. Lower in the capital structure compared to preferred stock

4. May not be redeemable

5. Has voting rights

Common Stocks vs Preferred Stocks | Similarities and Differences

What Is Perpetual Preferred Stock?

Perpetual preferred stock is a type of equity that pays fixed dividends and has no maturity date. This means that the preferred shareholder will continue to receive payments as long as the company remains in business.

Perpetual preferred shares are typically not redeemable, meaning that the shareholder cannot request that the company buy back their shares.

What Is Cumulative Preferred Stock?

Cumulative preferred stock is a type of equity that pays fixed dividends and has priority over common stock in the event of a liquidation. This means that if the company does not have enough money to pay all of its creditors, the cumulative preferred shareholders will be paid first.

Cumulative preferred shares also have cumulated dividends, which means that if the company misses a dividend payment, it will be carried over to the next period.

What Is Convertible Preferred Stock?

Convertible preferred stock is a type of equity that can be converted into common stock. This conversion typically happens at a predetermined price.

Convertible preferred shares typically have a higher dividend rate than common stock, but they also have fewer voting rights.

Advantages Of Investing In Preferred Stock

Higher Dividend Yields

Preferred stocks typically offer higher yields than common stocks, bonds, and other fixed-income investments. Of course, it will depend on the investment.

Lower Volatility

Preferred stocks also tend to be less volatile than common stocks. This is because preferred stock is senior in a company’s capital structure, making it less risky and of lower duration (i.e., its cash flows may be perpetual but more predictable).

Disadvantages Of Investing In Preferred Stock

Lack of Voting Rights

One of main disadvantages of investing in preferred stock is that the shareholders do not have voting rights.

This means that cannot vote on issues such as the election of the board of directors.

Calls and Redemptions

Another disadvantage of investing in preferred stock is that the shares can be called or redeemed by the issuing company.

This means that the company can force the shareholders to sell their shares back to the company at a predetermined price.

Less Capital Appreciation Potential

Preferred stocks also have less capital appreciation potential than common stocks. This is because the prices of preferred stocks are more influenced by changes in interest rates than changes in the underlying company’s performance.

Is Preferred Stock Good for Daytrading?

Preferred stock is less liquid than common stock, so it may be more difficult to buy and sell preferred shares during the day.

However, preferred stock typically has less volatility than common stock, so it may be a good choice for investors who are looking for stability.

Preferred Stock Dividends

Preferred dividends are typically paid on a quarterly basis, but they can also be paid monthly or annually.

The dividend payments are fixed, which means that they will not fluctuate with the underlying company’s performance.

Preferred Stock Taxes

Preferred stock is taxed as a capital gain, which means that the shareholders will only owe taxes on the profits from the sale of the shares.

How to Buy Preferred Stock?

Preferred stocks can be bought and sold through online brokerages. Brokerages may charge a commission for each trade.

Preferred stocks can also be bought through mutual funds and exchange-traded funds (ETFs). These funds typically hold a basket of stocks, so the investors will own a small piece of each company in the fund.

The most common preferred stock ETFs are under the ticker symbols:

• iShares Preferred and Income Securities ETF (PFF)
• Global X SuperIncome Preferred ETF (SPFF)
• Invesco Preferred ETF (PGX)
• SPDR ICE Preferred Securities ETF (PSK)
• Invesco Variable Rate Preferred ETF (VRP)

Many preferred stock ETFs pay dividends monthly.

When Should You Sell Preferred Stock?

There is no set time to sell preferred stock.

Investors typically sell their shares when they want the money to buy something else (a different financial asset or a good or service) or when they believe that the stock price will go down.

If an investor believes that the stock price will go down, they may choose to sell their shares and reinvest the proceeds into a different investment or hold it in cash or something that’s less volatile.

Who Likes to Invest in Preferred Stock?

Preferred stock is often purchased by those who want a combination of:

• the greater stability of debt investments
• the upside of equity, and
• the income benefit of receiving dividends

Preferred stock may also be attractive to investors who are looking for an alternative to bonds plus a premium.

Correlations with Other Major Asset Classes

Asset Correlations

Warren Buffett’s Take on Preferred Stock

Why Issue Preferred Stock?

He gives three reasons:

1) Flexibility for Acquisitions

Buffett explains that this is simply a way to give the company more options when buying businesses.

2) Seller Preferences

Some sellers of businesses don’t want cash (due to taxes) or common stock (due to market risk/volatility).

• Tax Benefits – Preferred stock can be structured to allow for a tax-free exchange for the seller.
• Income Security – A seller might prefer a steady income stream (via a fixed dividend) rather than the ups and downs of owning common shares.

3) Another Form of Currency

Buffett views preferred stock as just another form of “currency” (like cash or common stock) to pay for acquisitions. 

The goal is to match the desires of the seller to close the deal.

Shareholder Concerns about Preferreds

1) Dilution Risk

A shareholder asks if issuing this stock “dilutes” current owners or prints “fiat currency.”

Buffett’s Rebuttal = He argues that dilution only happens if you overpay. If Berkshire issues $200 million in stock but gets a business worth $200 million in return, no value is lost. The specific type of currency (cash, common, or preferred) matters less than knowing that the deal is fair.

2) “Back of the Line”

The shareholder also worries that preferred stock pushes common shareholders to the “back of the line” (since preferred holders get paid first).

Buffett’s Rebuttal = He compares this to borrowing money from a bank. If Berkshire borrows cash to buy a business, the bank also gets paid before shareholders. The trade-off is acceptable if the new business adds enough value to make everyone richer in the long run.

The “Chain Letter” Warning

Buffett and Munger warn against managements that view issuing stock as “free money.” 

Munger tells a story about a bank executive who thought stock options cost the company nothing, calling such managers “Judas in your midst.”

Buffett tells shareholders that Berkshire will only issue this stock if they get equal or greater value in return.

FAQs – Preferred Stock

What is the Difference Between Convertible Preferred Stock and Non-Convertible Preferred Stock?

Convertible preferred stock can be converted into common stock, while non-convertible preferred stock cannot.

Non-convertible preferred stock typically has a higher dividend yield than convertible preferred stock.

Both types of preferred stock typically have less voting rights than common stock.

Non-convertible preferred stock is the more common of the two.

What is the Difference Between Cumulative Preferred Stock and Non-Cumulative Preferred Stock?

Cumulative preferred stock means that if the issuing company misses a dividend payment, it will still owe the shareholder the missed payments. Non-cumulative preferred stock does not have this feature.

What is the Difference Between Participating Preferred Stock and Non-Participating Preferred Stock?

Participating preferred stock gives the shareholders the right to receive additional dividends if the company declares a dividend on their common shares. Non-participating preferred stock does not have this feature.

Participating preferred stock typically has a lower dividend yield than non-participating preferred stock.

Why do companies issue preferred stock?

There are a few reasons.

One is that it can be used to raise capital without increasing the number of shares outstanding and diluting existing shareholders’ equity stakes.

Another reason is that it can be used as a way to compensate executives and other key employees with something that has a higher claim on assets and earnings than common stock, but without giving them actual voting control of the company.

Preferred stock can also be used to shore up the balance sheet by adding another layer of security for creditors in the form of fixed-rate dividends that have priority over common dividends.

What are the disadvantages of preferred stock?

The main disadvantage of preferred stock is that it often pays fixed dividends, which can become a burden to companies if interest rates rise and the company’s earnings fall.

Preferred stock is also less liquid than common stock, so it can be hard to sell if you need to raise cash in a hurry.

Finally, preferred shareholders may have little say in how the company is run since they typically don’t have voting rights.

Summary – Preferred Stock

Preferred stock is a type of stock that may have any combination of features not possessed by common stock including properties of both an equity and a debt instrument, and is generally classified as a hybrid instrument.

Preferred shares are senior to common shares but subordinate to bonds in terms of claim or rights to dividends and assets. Holders of preferred shares typically do not receive voting rights, but they may have preferential treatment with respect to the distribution of dividends and the liquidation of assets.

Preferred stockholders are on the whole more protected than common shareholders, but less so than bondholders. They rank between common equity and debt in a company’s capital structure. Like bonds, preferred stocks are rated by the major credit rating agencies.

Sometimes preferred stock is convertible into common stock, giving the holder the opportunity to participate in the growth of the company if its stock price increases.

Preferred stock is a type of equity that typically pays fixed dividends and has priority over common stock in terms of dividend payments and asset claims.