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Preferred stocks are a class of ownership within a corporation that has a higher claim on its assets and earnings than common stock. Preferred shares usually have a dividend that must be paid out before dividends to common shareholders and the shares tend not to carry out any voting rights. Preferred shares have less potential to appreciate in price than common stock and they tend to trade within a few dollars of their issue price, which is most commonly $25. Preferred stock combines the features of debt and equity as it pays fixed dividends and has the potential to appreciate in price. The details of each preferred stock hinges on the issue.
Some preferred stocks are convertible, which essentially means that under certain circumstances it can be exchanged for a given amount of common shares. The board of directors may vote to convert the stock; the investor may have the option to convert or the stock may have a specific date at which it automatically converts. To know whether this is beneficial to the investor depends to the market price of the common stock.
If a company was struggling and as a result had to suspend its dividend, other preferred shareholders may have the right to receive payment in areas before the dividend can be continued for common shareholders. Shares with this arrangement are known as cumulative. If a company has several simultaneous issues of preferred stock, then it may be ranked in terms of priority. The highest ranking is named ‘prior’, followed by first preference, second preference, third preference etc.
Preferred stocks and common stocks tend to be confused with each other; however they do have their differences. Preferred stockholders have a better claim to a company’s assets and earnings. This is true during the particularly good times when a company has additional cash and decides to allocate the money in the form of dividends to its investors. In this event when distributions are made, preferred stockholders must be paid before common stockholders. This claim is only most significant during times of bankruptcy when common stockholders are last in line for the company’s assets. This essentially means that when the company must liquidate and pay all creditors and bondholders, common stockholders do not receive any money until after the preferred shareholders are paid. The other difference is that the dividends of preferred stocks are different from and are usually greater than common stocks. When you buy a preferred stock, you will gain an idea of when to expect a dividend as they are paid at regular intervals. This isn’t necessarily the case for common stocks, as the company’s board of directors will choose whether or not to pay out a dividend. Due to this feature, preferred stock typically doesn’t fluctuate as often as a company’s common stock and can occasionally be classified as a fixed-income security.
There are many advantages to preferred stocks; one being that there is no obligations for dividends. A company is not likely to pay a dividend on preference shares if its profits in a certain year are insufficient. With preference stocks there are no interferences as they don’t usually carry out voting rights, as mentioned above, which as a result means a company a can raise capital without dilution of control. They also create no mortgages or charge on the assets of the company. The company is able to keep its fixed assets free for raising loans in the future.
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