All About Preferred Stocks

Here’s an overview of everything you should know about preferred stocks before adding them to your portfolio.

Are Preferred Stocks more like Bonds or Stocks?

Preferred stocks are a special class of shares that are traded like stocks but actually represent debt, like a bond or loan. They do not represent or confer ownership, and the distributions rarely go up. So you’d only buy a preferred for steady income, not capital gains.

That said, preferred stock can generate very steady income. The yields are usually between 4% and 8%. And preferred shareholders are usually better protected—both in and out of bankruptcy—than common stock holders.

Preferred stock is usually issued at a par value of $25.00, although shares are sometimes issued for different amounts, including $50 and $100. When the shares are issued, the company announces the shares’ coupon rate and consequent annual dividend (which is the par value times the coupon rate). Although the coupon rate determines the annual dividend at the outset (because preferred shares are debt, prevailing interest rates and credit conditions will determine at what rate the company can issue preferreds), the annual dividend is actually the number that won’t change over time. The “coupon rate” or yield may.

For example, a company that wants to issue preferreds yielding about 8% would declare an annual dividend of $2 (because $2 ÷ $25 = 0.08). Once the preferreds are trading, the annual dividend won’t change, so the yield may vary slightly. Most preferreds issued at $25 will trade in a range between $23 and $27, depending on market conditions and investor sentiment about the company and the preferreds. If the preferreds are trading at $26, then the current yield on the shares will be 7.69% ($2 ÷ $26 = 0.0769).

While preferred stock dividends still have to be “declared” by a company’s board quarter-to-quarter or year-to-year (unlike bond distributions, which are mandated), they usually won’t change. In addition, preferred stock dividends are very safe because they are paid before dividends on the common stock.

Preferred stock dividends are also usually cumulative, meaning that if the company doesn’t pay some (or all) of its promised distributions, investors will receive them at a later date. The unpaid portion is considered “dividends in arrears” and must be paid before any other dividends. Check to make sure your preferred is “cumulative” to see if it has this feature. If it’s “non-cumulative,” skipped dividends don’t have to be made up.

Most preferreds are also callable. Callable preferreds will have a call price (usually also $25) and a call date. On or after the call date, the company has the right to buy back the preferreds from investors for the call price. The company has no obligation to call its preferreds, and many preferreds are not called for years after their call dates. A company is most likely to call its preferreds if interest rates have dropped and the company can now issue less-expensive debt.

If your preferreds are called, you’ll receive the call price of the shares plus any unpaid dividends. Having your preferred stock called can be a good thing if you bought it below the call price, and a bad thing if you paid too much for it. You can use an online bond yield calculator to determine your potential yield to call before deciding whether to buy a preferred at a specific price.

Some preferreds also have maturity dates, which is a date, between 30 and 100 years after the issue date, when the preferreds must be called.

And some preferred stock is convertible, meaning it can be converted into ordinary stock on or after a given date. This option gives preferred stockholders more potential upside.

One downside to preferred stock is that preferred holders usually don’t have voting rights as common stockholders do.

Lastly, while preferred stock is theoretically as easy to buy and sell as common stock, some preferreds are traded very lightly and it may be hard to get the price you want. I’d recommend avoiding preferred stocks trading less than 4,000 shares daily, on average. In addition, preferred ticker symbols are not standardized—they usually take the form of the issuing company’s stock symbol followed by a letter indicating the preferred series, but some also include dashes, dots or a ‘P’ for preferred—so always double check to make sure you’re buying the preferred you want.

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