Preferred stock is often issued by a company for a special purpose. For
example, if a company wanted to gain enough money for building a new
plant, they might choose to issue preferred stock. Preferred stock
might also be issued as compensation to directors or others.
The exact nature of shares of preferred stock are specified when they
are issued. In general shares of preferred stock do not represent
ownership as do shares of common stock. Often holders of preferred
shares do not have the right to vote in election or on other matters.
Despite the lack of ownership, preferred stocks carry many advantages to
common shares. Holders of preferred shares often receive a higher
dividend than holders of common stock; however, the dividend for
preferred shares usually is fixed when the shares are issued and does
not rise as earnings increase as will dividends on common shares.
Another advantage is that holders of preferred shares often have
precedence over funds of the corporation. For example, dividends of
preferred shares are usually paid before those for common shares.
Some preferred stocks are also convertible. This
means that the shares can be converted into shares common stock. For
example, if IBM were to issue some convertible shares, they might
specify that each ten shares of preferred stock could be converted
into one share of common stock. Because of the possibility of
conversion, the price of the preferred stock will tend to rise if the
price of the common shares rise. In our above case, the price of the
preferred shares will likely never be less than 10% of the price of
the common stock since 10 preferred shares can always be converted
into a share of common stock.
Preferred stocks are normally suitable for wealth preservation and generation
of income. Their higher yields and preferential treatment when
allocating company funds tends to prevent them from falling as
rapidly as shares of the common stock. In the case of convertible
preferreds, the investor will also have the chance of receiving some appreciation since the price will tend to increase – although not as rapidly – when the price of the common increases.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.