Preferred stock, like common stock, is an equity security. The holder of a preferred stock owns a portion of the corporation. As its name suggests, preferred stock is stock that has certain preferences—for example, dividend preferences and liquidation preferences. Preferred stocks offer fixed dividend payments and may feature a maturity date, which is usually long term (e.g., 30 years). Other preferred stocks are perpetual, which means there is no maturity date at which the issuing corporation must repurchase its preferred stock at par value.
The preferences that a preferred stock has depend on the issuing corporation. But generally, preferred stocks have the following features: preference in dividends (dividends are paid on preferred stock before they are paid on common stock); fixed dividend payments (fixed amount of dividend paid unless the issuing corporation defers dividends); preference in liquidation (in the event of liquidation, preferred stockholders receive assets before common stockholders); and no voting rights. Despite having certain features similar to features of bonds – fixed payments and a higher liquidation preference than common stock – preferred stocks are not debt obligations of the issuing company. Preferred stocks also offer less potential for appreciation than common stock. Many preferred stocks are callable, which means that the corporation that issued the preferred stock has the option, but not the obligation, to repurchase preferred stocks from shareholders after a specified period of time. If interest rates have declined since the time the corporation issued the callable preferred stock, the corporation may repurchase its preferred stocks at their par value in favor of a new issue of preferred stock paying lower dividends, thus limiting the potential gains from investing in callable preferred stocks. With respect to dividend payments, preferred stock can be cumulative or non-cumulative. If a preferred stock is cumulative, then any unpaid dividends accumulate after each dividend period and must be paid to the preferred shareholders once the corporation is able to pay dividends again. If a preferred stock is noncumulative, then any unpaid dividends are lost to the preferred shareholder after the dividend period.
Due to the variable features of preferred stocks, it is important to understand the terms of any specific preferred stock before making an investment decision.