Within the spectrum of financial instruments, preferred stocks (or "preferreds") occupy a unique place. Because of their characteristics, they straddle the line between stocks and bonds.

Technically, they are equity securities, but they share many characteristics with 澳洲幸运5官方开奖结果体彩网:debt instruments. They're sometimes called 澳洲幸运5官方开奖结果体彩网:hybrid securities.

In this article, we look at preferred shares and compare them to some better-known 澳洲幸运5官方开奖结果体彩网:investment vehicles.

Understanding Preferred Stocks

Ther𓃲e are advantages for some investors buyin💜g preferred shares. The companies issuing shares of preferred stock can also realize some advantages.

Investors

• Preferred stock is attractive as it usually offers higher fixed-income payments than bonds with a lower investment per share.
• Preferred stockholders also have a priority claim over common stocks for dividend payments and liquidation proceeds.
• Its price is usually more stable than common stock.
• Furthermore, it is more liquid than corporate bonds of similar quality.
• 澳洲幸运5官方开奖结果体彩网:Internal Revenue Service (IRS) rules make it attractive for institutions to invest in preferred stock. Under what is known as the 澳洲幸运5官方开奖结果体彩网:dividends received deduction, a U.S. corporation receiving dividends from a domestic company may deduct up to 50% of the income from its taxes if it owns less than 20% of the dividend payer. If the corporation owns more than 20%, it can deduct 65%.
• The fact that individuals are not eligible for such advantaged tax treatment should not exclude preferreds from their consideration as a viable investment.

Issuers

• Preferred stock offers flexibility in payments to issuers. Preferred dividends may be suspended in case of corporate cash problems.
• Preferred stock is easier to market. It's typically bought and held by 澳洲幸运5官方开奖结果体彩网:institutional investors, which may make it easier to sell during an 澳洲幸运5官方开奖结果体彩网:initial public offering.
• Preferred stock often has a callable feature that allows the issuing corporation to forcibly cancel the outstanding shares for cash. This precludes investors from participating in any future price appreciation. It also doesn't specify the maturity date which injects uncertainty over the recovery of invested principal. There is limited appreciation potential, no voting rights, and it is sensitive to interest rates.
• Issuers 澳洲幸运5官方开奖结果体彩网:do not receive an immedia𝓡te tax dedဣuction as they would for the interest paid on bond issues.

Types of Preferred Stock

Although the possibilities are nearly endless, these are the basic types of preferred stoc✃ks:

• Cumulative. Most preferred stock is 澳洲幸运5官方开奖结果体彩网:cumulative, meaning if the company withholds part or all of the expected dividends, they are considered dividends in arrears and must be paid before any other dividends. Preferred stock that doesn't carry the cumulative feature is called straight, or 澳洲幸运5官方开奖结果体彩网:noncumulative preferred.
• Callable. Most preferred shares are redeemable, giving the issuer the right to redeem the stock at a date and price specified in the 澳洲幸运5官方开奖结果体彩网:prospectus.
• Convertible. The timing for conversion and the 澳洲幸运5官方开奖结果体彩网:conversion price specific to the individual issue will be laid out in the preferred stock's prospectus.
• Participating. This is preferred stock that has a fixed 澳洲幸运5官方开奖结果体彩网:dividend rate. If the company issues 澳洲幸运5官方开奖结果体彩网:participating preferreds, those stocks gain the potential to earn more than their stated rate. The exact formula for participation will be found in the prospectus. Most preferreds are non-participating.
• Adjustable-Rate Preferred Stock (ARPS). These preferreds pay dividends based on several factors stipulated by the company. Dividends for ARPS are keyed to yields on 澳洲幸运5官方开奖结果体彩网:U.S. government issues, providing the investor limited protection against adverse interest rate markets.

Bonds and Preferreds

Because preferred shares are often compared with bonds and other debt instruments, let's look at their similarities and differences.

Similarities

1. Preferreds are issued with a fixed par value and pay dividends based on a percentage of that par, usually at a fixed rate. Just like bonds, which also make 澳洲幸运5官方开奖结果体彩网:fixed payments, the 澳洲幸运5官方开奖结果体彩网:market value of preferred shares is sensitive to changes in interest rates. If interest rates rise, the value ﷽of the preferred shares falls. If rates decline, the opposite would hold true. However, the relative move of preferred yields is usually less dramatic than that of bon🦄ds.

2. Preferreds technically have an unlimited life because they have no fixed 澳洲幸运5官方开奖结果体彩网:maturity date, but they may be called by the issuer after a certain date. The motivation for the 澳洲幸运5官方开奖结果体彩网:redemption is generally the same as for bonds—a compa🥂꧅ny calls in securities that pay higher rates than what the market is currently offering. Also, as is the case with bonds, the redemption price may be at a premium to par to enhance the preferred's initial marketability.

3. Like bonds, preferreds are senior to common stock. However, bonds have more seniority than preferreds. The seniority of preferreds applies to both the distribution of corporate earnings (as dividends) and the liquidation of proceeds in case of bankruptcy. With preferreds, the investor is standing closer to the front of the line for payment than 澳洲幸运5官方开奖结果体彩网:common shareholders, although not by much.

4. As with 澳洲幸运5官方开奖结果体彩网:convertible bonds, preferreds can often be converted into the common stock of the issuing company. This feature gives investors flexibility, allowing them to lock in the fixed return from the 澳洲幸运5官方开奖结果体彩网:preferred dividends and, potentially, to participate in the 澳洲幸运5官方开奖结果体彩网:capital appreciation of the common stock.

5. Like bonds, preferred stocks are rated by the major credit rating companies, such as 澳洲幸运5官方开奖结果体彩网:Standard & Poor's and Moody's. The rating for preferreds is generally one or two tiers below that of the same company's bonds because preferred dividends do not carry the same guarantees as interest payments from bonds and they are junior to all 澳洲幸运5官方开奖结果体彩网:creditors.

Differences

1. As observed earlier, preferred stock is equity while bonds are debt. Most debt instruments, along with most creditors, are senior to any equity.

2. Preferreds pay dividends. These are fixed dividends, normally for the life of the stock, but they must be declared by the company's 澳洲幸运5官方开奖结果体彩网:board of directors. As such, there is not the same array of guarantees that are afforded to bondholders. With preferreds, if a company has a cash problem, the board of directors can decide to withhold preferred dividends. The 澳洲幸运5官方开奖结果体彩网:trust indenture prevents companies from taking the same action on their 澳洲幸运5官方开奖结果体彩网:corporate bonds.

3. Another difference is that preferred dividends are paid from the company's after-tax profits, while bond interest is paid before taxes. Thi🤡s factor makes it more expensive for a company to issue and pay dividends on preferred stocks.

4. Computing 澳洲幸运5官方开奖结果体彩网:current yields on preferreds is similar to the calculation on bonds where the annual dividend is divided by the price. For example, if a preferred stock is paying an annualized dividend of $1.75 and is currently trading in the market at $25, the current yield is: $1.75 ÷ $25 = .07, or 7%. In the market, however, yields on preferreds are typically higher than those of bonds from the same issuer,🐼 reflecting the higher risk the preferreds present for investors.

5. While preferreds are interest-rate sensitive, they are not as 澳洲幸运5官方开奖结果体彩网:price-sensitive to interest rate fluctuations as bonds.✃ However, their prices do ꦬreflect the general market factors that affect their issuers to a greater degree than the same issuer's bonds.

6. Information about a company's preferred shares is easier to obtain than information about the company's bonds, making preferreds, in a general sense, perhaps more liquid and easier to trade. 澳洲幸运5官方开奖结果体彩网:The low par values of the p☂referred shares also make investing easier, because bonds (with par values around $1,000) oftꦕen have minimum purchase requirements.

Common Stock and Preferred Stock

Similarities

Both are equity instruments. Their dividends come from the company's after-tax profits and are taxable to the shareholder (unless held in a tax-advantaged account).

Differences

Preferreds have fixed dividends and, although they are never guaranteed, the issuer has a greater obligation to pay them. Common 澳洲幸运5官方开奖结果体彩网:stock dividends, if the𝐆y exist at all, are paid after the company's obli𝕴gations to all preferred stockholders have been satisfied.

The lower 澳洲幸运5官方开奖结果体彩网:volatility of preferred stocks may look attractive, but it cuts both ways: Preferreds aren't as sensitive to a company's losses, but they will not share in a company's success to the same d🍰egree as common stock.

This is where preferreds lose their luster for many investors. If, for example, a pharmaceutical research company discovers an effective cure for the flu, its common stock is likely to soar, while the preferreds might only increase by a few points.

Whereas common stock is often called voting equity, preferred stocks usually have no 澳洲幸运5官方开奖结果体彩网:voting rights.

The Bottom Line

There are a number of strong companies in stable industries that issue preferred stocks that pay dividends above 澳洲幸运5官方开奖结果体彩网:investment-grade bonds. So, if you're seeking relativelyౠ safe returns, you shouldn't overlook the preferred stock market.

However, an individual investor looking into preferred stocks should carefully examine both their advantages and drawbacks. The starting point for research on a specific preferred is the stock's prospectus, which you can often find online.