Things To Know About Preferred Stocks
A preferred stock is a type of hybrid stock that provides dividends prior to any dividend paid to common stocks (have a higher claim to dividends or asset distribution than common stockholders) including properties of both an equity and a debt instrument.
So, is preferred stock a hybrid security ? Yes.
Why preferred stock is hybrid security ? It is because preferred stocks including properties of both an equity and a debt instrument and have a higher claim to dividends.
Importance of preferred stocks
Preferred shareholders have priority over common stockholders when it comes to dividends
The rank of preferred stock is higher than usual stocks but in the conditions of claim, it ranks lower than bonds. In terms of liquidation and dividend payments preferred stock is better than common stocks. The terms of preferred stock are explained in the articles of incorporation or association of the issuing companies. Moreover, preferred stocks are evaluated like bonds by major companies of credit rating. But these stocks are rated lower than bonds because the dividends of stocks are not guaranteed as the payment of interest on the bonds.
Features of preferred stocks
The shares which have a naumber of features not found in normal stocks are known as preferred stocks. Some of the features of the preferred stocks may include:
Preference in dividends: The preference of preferred stocks is to pay dividends but does not assure to pay it which should be paid while paying dividends on common stocks. There are two types of preferred stocks- non-cumulative and cumulative. The number of payable dividends is accumulated to pay later on, in case of cumulative preferred stocks, if the company does pay the passed’ dividends at the scheduled time. All the amounts of unpaid passed’ dividends on cumulative stocks become arrears on dividends. But in case of non-cumulative preferred stocks, you may lose passed dividends if they are not declared by the issuing company.
Preference in assets: In the case of liquidation, preferred stock is considered as an asset as it does not have a predetermined value to be liquidated. The money invested at the time of the initial issuing of stocks is represented in terms of preferred stocks. They can be liquidated at their value in the stock market, at par or at the negotiated price. This feature makes preferred stocks better than common stocks.
Call-ability to allow the holder to redeem it before maturity: Preferred stocks in the U.S. usually have a provision to call which allows the issuing company to buy back the stocks as per its discretion.
Higher yields in dividends: Most of the preferred stocks have a fixed amount of dividend but in certain cases it can be negotiable. Normally dividend is mentioned in terms of certain percent of the face value or a set amount but if it is negotiable then it can vary according to the benchmark index of the interest rate.
Non-voting: Some of the preferred stocks have special rights to vote for the approval of exceptional events like electing the directors but they must have arrears of preferred dividends many times to avail this right. Usually, preferred stocks have no voting rights.
Types of preferred stocks
Along with cumulative and noncumulative preferred stocks, other types of these stocks may comprise of:
Prior preferred stock: These stocks are designated as the stocks of the highest priority. The company makes payment on the prior preferred stocks if enough money is available with the company to meet the schedule of the dividend on the preferred stocks. So the risk of credit is less in prior preferred stocks than preferred stocks of other types.
Preference preferred stock: These stocks are preferred than other preferred stocks because they are issued by the companies when they issue more than one issue of preferred stocks and rank them on their seniority.
Convertible preferred stock: A predetermined number of these preferred stocks can be exchanged with the common stocks of the company. But once to stocks are converted into common stocks cannot be converted to preferred stocks again.
Exchangeable preferred stock: These preferred stocks can be exchanged with other types of securities.
Participating preferred stock: The holders of these stocks can get their predetermined dividend regularly even if the company performs well or not. But they can get an additional dividend from the company if the company has achieved its financial targets.
Perpetual preferred stock: The date of the refund of invested capital to the investors in these stocks is not fixed. So, for this reason, these stocks are issues without any date of redemption.
Putable preferred stock: These stocks are privileged with the Put’ option which allows their holders to force the issuing company to redeem their stocks when required.
Monthly income preferred stock: These stocks have a combination of subordinated debts and preferred stocks. The holder of these stocks earns a monthly income on their investments.
Usage of preferred stocks
A company uses preferred stocks as a source of financing just like funds from the pension earning people. Sometimes, companies go into arrears of dividends by delaying their payment against some penalty. It can affect the credit rating as well as a negative effect on the financial contracts of the company as it is not meeting the required conditions. Still, it is better than traditional debt as the company can be in default if the payment of the debt is missed.
Preferred stocks are occasionally used by the companies for creating stocks with conversion features or features of forced exchange or to prevent the aggressive takeovers to avoid any change in control. Some of the companies, while issuing preferred stocks, authorize their board of directors to determine the terms and conditions of the stocks by mentioning provisions in their charters. In this way, these stocks are used as blank checks’ to defend the company from takeover by assigning them the superpower of voting or a very high value of liquidation.
The company must have enough money to repay the capital of the holders of preferred senior’ stocks when it is going bankrupt. In this situation, they can ignore the payment of junior’ stocks. For this reason, while issuing preferred stocks for the first time, their documents may include provisions to prevent the issuing of new stocks to be claimed as senior stocks. There can be a senior, equal or junior relationship between a series of preferred stocks and preferred stocks of other series of the same company.