What is preferred stock?
Preferred stock is a hybrid security, meaning it is not a stock or a bond. Preferred stock is an equity security that shows ownership in a company. In most cases, preferred stock is offered to the public by the issuing company to acquire another company, or to improve capital and expansion at a time when stockholders and the public are not buying common stock. Unlike common stock, preferred stock does not fluctuate very much in price. Since very little price fluctuation occurs, large short-term profits or losses are unlikely.
Why would an investor buy preferred stock?
Investors buy preferred stock because they receive dividend payments and will likely receive their principal back when they sell their position. Preferred stock normally gives the investor a chance to have a steady income over an extended period of time. Since dividends are paid on preferred stock before common stock, investors view preferred stock dividends as a more steady source of income than common stock dividends.
Do preferred stockholders have any voting rights?
There are essentially no voting rights that come along with the purchase of preferred stock. After a certain number of quarters with no dividends received, preferred stockholders may be compensated with shares of common stock. Keep in mind, this is an indefinite feature and does not have a time limitation. The company has the right to buy out preferred stockholders at a given price, or at any given date in the future, for a formula price set at the time an investor purchased the stock.
What does Henssler Financial recommend for investors?
Our recommendation is plain and simple: Do not buy. There is a misconception that preferred stock pays a constant dividend, but keep in mind, in most cases the dividend is not guaranteed if a company experiences a decline in earnings. Dividends received from preferred stock are taxable to the individual investor. Preferred stock is attractive to corporations because they can exclude most of the dividends received in the calculation of their taxable income. Therefore, the yield received by individual investors does not compensate them for the risk of the security. Preferred stock is also inferior to debt, because when a company files for bankruptcy, all the bondholders receive their claim before preferred stockholders receive their claims, if anything is available.
Better options than preferred stock will almost always exist for the investor. If funds are not needed within the next 10 years, common stock is a better choice. If funds are needed, U.S. government bonds or high-grade municipal bonds are better choices.