Definition of Preferred Stock
Preferred stock is a type of capital stock issued by some corporations in addition to its common stock. Preferred stock is also known as preference stock. The word “preferred” refers to the dividends paid by the corporation and to the liquidation of the corporation (if that were to occur). In exchange for this preferential treatment, the preferred stockholders (shareholders) generally will never receive more than the preferred stock’s stated fixed dividend.
The preferential treatment for dividends means that preferred stockholders will receive their dividends before the common stockholders are to receive any dividend.
Preferred stock is relatively rare since corporations will use debt in addition to its common stock.
Example of Preferred Stock
Assume that a stockholder owns 100 shares of a corporation’s 8% $100 par preferred stock. Each year, this stockholder must receive dividends on the preferred stock of $800 (8% X $100 = $8 per share X 100 shares) before the common stockholders are allowed to receive any cash dividends for the year. Unless the preferred stock has a participating feature, this preferred stockholder will never receive more than $8 per share no matter how successful the corporation becomes.
The preferred stock could have any of the following features: cumulative, convertible, callable, participating, and more.
Since the dividend on preferred stock is usually a fixed amount forever, once the preferred stock is issued its market value is likely to change in the opposite direction of inflation. The higher the rate of inflation, the less valuable are the fixed dividend amounts. If the inflation rate declines, the value of the preferred stock is likely to increase, but no higher than the preferred stock’s call price.
