Preferred stock occupies a unique place in the scope of financial tools. Due to the properties of preferred stock, they fall somewhere in between stocks and bonds.
They are technically equity securities, however they are very similar to debt instruments. Analysts may sometimes refer to them as hybrid securities, in light of their similarities to both stocks and bonds.
Similarities Between Preferred Stock And Bonds
Preferred stocks are senior to common stock, and similar to corporate bonds. Bonds, however, remain senior to preferred stock. This seniority applies to the liquidation proceeds in the event of a bankruptcy, as well as distribution of company earnings as dividends.
Preferred stocks can usually be changed into common stock, similar to convertible bonds, offering flexibility by allowing investors to lock in the fixed returns from the preferred stock dividends. This feature also allows for the participation in the capital appreciation of the common stock.
These types of investments are also sensitive to interest rates, as they are issued with a set par value. Preferred stocks also pay out dividends based on a percentage of that par at a fixed rate. This makes the marked value reactive to changing interest rates, although the movement of preferred stock yields is normally less striking than that of bonds.
Preferred Stock Drawbacks
As with every investment option, there are drawbacks to owning preferred stock. One such disadvantage is that preferred stock is riskier than bonds. Preferred stock loses value as interest rates rise.
Preferred shares do not tend to appreciate as fast as common stock. While preferred stock offers low-volatility, your preferred shares could go nowhere while the company’s common stock soars.
Getting Started With Preferred Stock
Investing in preferred stock is similar to investing in common stock in that they both require doing your research. Maybe you are interested in investing in a company that you know well, or maybe you are curious about investing in preferred stock but haven’t picked a corporation to invest in yet.
Either way, you must still do some market research, either with the help of a professional stock broker, or on your own. It is important to start with a few companies that you may be interested in, that you make sure that they are corporations that you can believe in, and that they will rise in value over time.
It is advised that you carefully review the preferred stock prospectus, and look for whether the dividends are cumulative, find out if the shares are redeemable and when, and whether the company’s board of directors has ever halted the payment of dividends.
Preferred stock is purchased and sold just like common stock. There are often more than one series issued by a company, and they often use letters to set them apart.
An investor who is considering placing capital in preferred stock should thoroughly analyze their pluses and minuses. Many strong corporations, in stable sectors issue preferred stocks paying dividends above investment-grade bonds.
Preferred stock offers investors a low-volatility option and relatively safe returns, and should not be overlooked as a potential investment.
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