All Types of Preferred Stock Explained

Do you remember how many types of preferred shares there are? No? Don’t worry! We are here to help you.

Let’s start from the beginning.

Preferred stock, also known as preferred stock, represents a class of ownership in a corporation that has greater claims on assets and earnings than common stock.

These shares are called “preferred” because they have preferential rights over common shares. These rights may relate to dividends, capital repayment or other features. Here are nine different types of preferred stock:

Cumulative preferred shares:

Definition: If a company does not pay dividends in a year, holders of cumulative preferred shares are entitled to receive the omitted dividends in subsequent years.

Characteristics: These shareholders are in a priority position to receive any dividends due before any dividends are paid to ordinary shareholders.

Example: If a company failed to pay dividends for 2 years but makes a profit in the third year, the cumulative preference shareholders would first receive their dividends for the last two missing years before distributing the dividends to other shareholders.

Non-cumulative preferred shares:

Definition: Unlike cumulative preferred stock, these shareholders are not entitled to receive dividends that were omitted in previous years.

Characteristics: If the company fails to pay a dividend in any year, these shareholders lose their right to that dividend permanently.

Example: If a dividend is not declared in one year, non-cumulative preference shareholders will not receive it in subsequent years, even if the company becomes profitable again.

Participating and non-participating preferred shares:

Definition: These shareholders not only receive a fixed dividend but are also entitled to share in the excess profits after all dividends are paid to the other shareholders.

Characteristics: They allow shareholders to benefit from both the stability of fixed dividends and the possible advantages of a company’s success.

Example: After paying dividends to all shareholders, if any profit remains, participating preference shareholders will receive an additional portion of the profit.

Definition: Shareholders receive only a fixed dividend and cannot participate in any additional dividends that may be available after all other dividends are paid.

Characteristics: They offer stability with their fixed dividends, but no additional benefits from excess profits.

Example: Even if the company makes excess profits after distributing dividends, the non-participating preferred shareholders will not receive a share of them.

What about other types of preferred stock?

Convertible preferred shares and non-convertible preferred shares:

Definition: Shareholders have the option to convert their preferred shares into common shares after a specified period.

Characteristics: Offers a combination of the safety of preferred stock and the upside potential of common stock.

Example: A holder of convertible preferred stock might decide to convert it into common stock to capitalize on company growth and potentially higher dividends in the future.

Non-convertible preferred shares:

Definition: These shares cannot be converted into common shares.

Characteristics: They remain preferred shares throughout their existence, offering a fixed dividend but no upside conversion potential.

Example: They are suitable for investors seeking stable income without the volatility associated with common stocks.

Redeemable preferred shares and irredeemable preferred shares:

Definition: These shares are issued with the understanding that the company will redeem them after a certain period.

Characteristics: They provide fixed dividends and are returned at a fixed price once the holding ends.

Example: An investor can purchase redeemable preferred shares that promise to return the principal amount after 10 years.

Irredeemable preferred stock (or perpetual preferred stock):

Definition: These shares have no specific expiration date and the company is not required to redeem them.

Characteristics: They can exist as long as the company is operational, providing a continuous source of fixed dividend income.

Example: Suitable for investors seeking perpetual income without focusing on capital returns.

Adjustable Rate Preferred Stock:

Definition: The dividend yield on these stocks is tied to a benchmark interest rate, such as the prime rate.

Characteristics: The dividend can rise or fall depending on movements in the reference rate, offering a variable return.

Example: If the benchmark interest rate rises, the dividend on these stocks could increase, offering higher returns to shareholders.

Adjustable preferred shares

We can’t forget about adjustable preferred stock, when it comes to all types of preferred stock.

In the case of adjustable preferred shares, the dividend rate is not fixed and is influenced by current market rates.

In summary, preferred stock represents a class of ownership that combines characteristics of debt and equity, offering advantages to both corporations and investors.

For companies:

Diversified financing: Preferred stock provides an alternative source of financing beyond common equity and debt. This flexibility can be crucial during periods when a source of financing becomes too expensive or unavailable.

No dividend obligation: Unlike bonds, where interest payments are mandatory, companies are not required to pay dividends on preferred shares. However, if they are skipped, they may have to pay it later for the accumulated preferred stock.

Strengthening the balance sheet: Because they don’t require fixed payments like debt, lenders and rating agencies may view them more favorably, potentially improving credit scores.

For investors:

Biggest claim: Preferred shareholders have greater rights over assets and profits than ordinary shareholders. If a company goes bankrupt, preferred shareholders are paid before common shareholders during asset liquidation.

Dividend advantage: They typically receive dividends before common shareholders and often at a fixed rate, making them a more predictable source of income.

Convertible Features: Some preferred stocks offer the option to convert to common stock, allowing investors to potentially benefit from a company’s growth.