Preferred stocks occupy a unique middle ground between common stocks and bonds. They offer higher yields than most common stocks and more stability, while providing better returns than many bonds. In this guide, we will explain how preferred stocks work and whether they belong in your portfolio.
What Are Preferred Stocks?
Preferred stocks are a class of ownership in a company that has priority over common stock for dividends and assets in liquidation. They typically pay fixed dividends and behave more like bonds than traditional stocks.
The hybrid nature: Preferred stocks combine bond-like features (fixed payments, price stability) with stock features (equity ownership, no maturity date, potential tax advantages on dividends).
Key Features of Preferred Stocks
Fixed Dividends
Most preferred stocks pay a fixed dividend, typically expressed as a percentage of par value (usually $25). A 6% preferred with $25 par pays $1.50 annually.
Dividend Priority
Preferred shareholders receive dividends before common shareholders. If a company cannot pay all dividends, preferred holders get paid first.
Limited Upside
Unlike common stock, preferred shares have minimal price appreciation potential. They typically trade near their par value.
No Voting Rights
Most preferred shareholders cannot vote on company matters, unlike common stockholders.
Liquidation Preference
If the company is liquidated, preferred shareholders are paid before common shareholders (but after bondholders).
Types of Preferred Stock
Cumulative Preferred
If the company misses dividend payments, they accumulate and must be paid before any common stock dividends. Most preferred stocks are cumulative.
Non-Cumulative Preferred
Missed dividends are not owed later. The company has no obligation to make up skipped payments.
Convertible Preferred
Can be converted into a specified number of common shares. Offers upside potential if the common stock appreciates significantly.
Callable Preferred
The company can buy back shares at a specified price after a certain date. This limits upside but is common in most preferred issues.
Preferred Stock Example
- Company XYZ Series A Preferred
- Par value: $25
- Dividend rate: 6%
- Annual dividend: $1.50 per share
- Current price: $24
- Current yield: 6.25% ($1.50 / $24)
- Callable at $25 after 2028
Benefits of Preferred Stocks
Higher Yields
Preferred stocks typically offer yields of 5-7%, significantly higher than most common stock dividends or investment-grade bonds.
Dividend Stability
Fixed payments provide predictable income, similar to bond coupons.
Lower Volatility
Preferred stock prices are generally more stable than common stock prices.
Tax Advantages
Qualified preferred dividends may be taxed at lower rates than bond interest for US investors.
Priority Over Common Stock
In difficult times, preferred shareholders have first claim on dividends.
Risks of Preferred Stocks
Interest Rate Sensitivity
Like bonds, preferred stock prices fall when interest rates rise. A preferred paying 5% becomes less attractive when new issues pay 7%.
Call Risk
Companies may redeem preferreds when rates fall, forcing reinvestment at lower yields.
Credit Risk
If the company struggles financially, preferred dividends can be suspended (though cumulative preferreds must eventually catch up).
Limited Upside
Preferred stocks do not participate in company growth like common stock. You primarily earn the dividend.
Subordinate to Bonds
In bankruptcy, bondholders are paid before preferred stockholders.
When to Consider Preferred Stocks
Preferred stocks may be appropriate when:
- You need higher income than bonds currently provide
- You want more stability than common stocks
- Interest rates appear stable or declining
- You have a long time horizon and can hold through price fluctuations
- You are in a tax bracket where qualified dividends are advantageous
How to Invest in Preferred Stocks
Individual Preferred Shares
Buy specific preferred issues through your broker. Trade on exchanges like common stocks, often with ticker symbols ending in letters (e.g., XYZ-A).
Preferred Stock ETFs
Funds holding diversified portfolios of preferred stocks. Provide instant diversification and professional management.
Considerations When Buying
- Check the credit rating of the issuing company
- Understand call provisions and dates
- Compare current yield to other income investments
- Consider interest rate direction
Track Your Preferred Stock Investments
Pro Trader Dashboard helps you monitor all your investments including preferred stocks, track dividend income, and analyze your overall portfolio yield.
Summary
Preferred stocks offer a middle ground between common stocks and bonds, providing higher yields with more stability than common shares. They work well for income-focused investors who understand the interest rate sensitivity and call risks involved. Whether through individual issues or preferred stock ETFs, this asset class deserves consideration as part of a diversified income-generating portfolio.
Want to learn more about income investments? Check out our guides on income stocks and corporate bonds.