Preferred StocksInvestment Snapshot
* Preferred stock yields can be three to four times greater
than common stock yields. WHAT IS PREFERRED STOCK?Preferred stock is classified on a balance sheet as equity, but it has
many features that resemble debt securities. Equity is defined as
capital invested in a company by its owners; debt is capital lent to
the corporation, which must be repaid. Preferred stock is a hybrid
type of security in that it has characteristics resembling both debt
and equity. Generally, preferred stocks have a fixed dividend, but
owners of preferred stock do not have voting rights. Although preferred
stock is classified as equity, preferred stockholders do not
have ownership interests in the company. The failure of a company
to pay dividends to preferred stockholders does not result in bankruptcy,
as it would with the default of interest on bonds. Instead, the
company does not pay common stockholders any dividends until
the preferred stockholders are paid their dividends. Unlike common
stock, the dividend rate on preferred stock is usually fixed. It might
be stated as a percentage of the par value of the preferred stock or as
a fixed dollar amount. The par value is a stated value, and hence
a preferred stock issue with $100 par value that has a dividend of
8 percent would pay a dividend of $8 per share (8 percent of $100). REASONS TO INVEST IN PREFERRED STOCKThe fixed dividend of preferred stock appeals to investors who
seek regular payments of income, but in exchange for regular
income, preferred stocks do not experience large capital gains (or
losses). The downside to a fixed dividend rate is that the price of
preferred stock is sensitive to changes in market rates of interest
similar to bonds. For example, if you buy preferred stock for $100
a share that pays a dividend of $4, and market rates of interest
subsequently go up to 6 percent, there will be downside pressure
on the price of this preferred stock issue. New investors will not
want to buy this preferred stock for $100 when the dividend is
only $4 (a return of 4 percent, 4/100) and new preferred stock
issues return a higher yield. Prices of adjustable-rate preferred
stock issues do not fluctuate as much as the prices of fixed-rate
preferred stock issues with changes in interest rates. Thus preferred
stock is appealing to investors if interest rates remain stable
or decrease. |
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