What are preferred stocks?

Do you want a guaranteed dividend with security, though with less potential capital gain, however, also with less of a chance for loss of income, the preferred stock is the way to go?

Well to know if you want to go the route of preferred stock over any other stock, or in addition to, we need to know what preferred stock is.

Preferred stock is Capital stock, which provides a specific dividend that get paid before any dividends are paid to common stock holders, and which takes precedence over common stock in the event of bankruptcy. Therefore, you will be able to have confidence in the security of your stock.

Preferred stock is a mix of common stock and a bond. The preferred stock usually has a specific guarantee. The biggest consideration that would make the stability a loss is that you also lost the larger capital gain. Therefore, you have to decide what is your higher priority.

Just like the common stock, preferred stock represents partial ownership in a company. However, the preferred stock shareholders do not get any of the voting rights of common stockholders.

Preferred stock pays a fixed dividend. It will not fluctuate. However, a company does not have to pay this dividend if it lacks the financial ability to do so.

The biggest benefit to owning preferred stock is that the investor has a greater claim on the company's assets. This is more so than the common stockholder is.

There are four types of preferred stock.

1. Cumulative- Preferred stock on which dividends accrue in the event that the issuer does not make timely dividend payments. Most preferred stock is cumulative preferred. Opposite of non-cumulative preferred.
2. Non-cumulative-The opposite of cumulative preferred stock. Preferred stock for which unpaid dividends do not accrue.
3. Participating preferred stock-A type of preferred stock that gives the holder the right to receive dividends equal to the normally specified rate that preferred dividends receive as well as an additional dividend based on some predetermined condition.
4. Convertible preferred stock-Preferred stock that includes an option for the holder to convert the preferred shares into a fixed number of common shares, usually anytime after a predetermined date.

The dividends paid to the preferred shares will be deducted in taxes, as an expense because they are required payments, unlike the common stock dividend, which is just a splitting up of the profits.

Not unknown to all is that the most important characteristic of a preferred stock is if it is cumulative or non-cumulative.

In a cumulative issue, dividends that are not paid (referred to as "in arrears") build up. Before any dividend can be paid on the common stock, the entire in arrears balance must be paid in full.

If a preferred issue is non-cumulative and a dividend payment is not paid, the shareholders are out of luck. This is bad because they will most likely, never receive that money from the company even if and when the company gets onto more prosperous times.

Regardless if preferred stocks are listed as equity on the balance sheet, they should be viewed more like bonds than common stocks. Preferred stocks usually have a fixed dividend and carry no voting rights.

Preferred stocks will technically have an unlimited life but often are redeemable. As with any investment, before diving in, you should understand the company. With preferred stocks, you must understand the lingo as well. Know the area of business the company you are in investing in.

Preferred stocks will be bought and sold just like common stocks. Companies that issue them often have more than one series, using letters of the alphabet to distinguish them Like: Series A, Series B, Series C.

Preferred shares should have a higher yield than comparable debt. (Yield is the annual dividend divided by the price.) The hard part is matching preferred shares with debt because preferred stocks can have so many caveats. There are so many variations that decisions have to be made differing with each particular area.

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