Have you ever wonder why do investors want preferred stocks?
There is no doubt that many investors prefer to own preferred stocks of a company over common stocks. Preferred stocks, as the name implies, have numerous benefits, and owning them can be a more profitable source of earnings compared to owning common shares.
What are preferred stocks?
Preferred stocks are shares that allow shareholders to receive dividends from the company before equity shareholders. Preferred stocks provide greater security and trust to investors by allowing them to earn a more reliable and predictable return on their initial investment. Here’s an overview of the advantages and disadvantages of preferred stocks as compared to common stocks, which I will explain more below:
Advantages of Preferred Shares
There are numerous privileges associated with preferred stock. These benefits include the following:
1. Better Stability in Investment Returns
As a preferred stockholder, you are entitled to regular dividend payments that are frequently more than those paid by common stocks and bonds. These payments are also made on a more consistent basis, providing additional monetary stability. When the company wants to pay out more dividends, preferred shareholders are prioritised. In many circumstances, the company predetermines dividend payments. During this time, preferred dividend payments may be suspended. However, the company will be required to pay preferred shareholders before resuming dividends to common shareholders. While buying stock in a company always carries risks, preferred stock can help to reduce those risks. If a company declares bankruptcy while you are a preferred shareholder, you will be among the first to claim assets. However, it is important to remember that bondholders still rank higher in this list of distributions.
2. The Right to Convert Your Stock
Another potential benefit of owning preferred shares is that you can convert them to common stock whenever you wish. The obvious advantage here is that you can buy common stock if the price rises. If the price of common stock increases sufficiently, you can sell this common stock for an immediate return on your initial investment. Keep in mind that if you do decide to trade your preferred stock, you will lose all of the previously listed benefits, and you will also not be able to convert your common stock back to preferred stock. This is one of the reasons why investors would favour preferred shares.
Are there Disadvantages to Owning Preferred Shares?
While preferred shares have an advantage over common stocks, there are a few drawbacks to consider:
1. Ownership of Company
As a common shareholder, you have true ownership of the company. Your name will be reflected as a shareholder on the company’s registry. On the other hand, if you’re a preference shareholder, you will not have this ownership and will not be regarded as the company’s owner.
2. Voting Rights
Voting rights is also one of the only areas where common stocks have an edge over preferred stocks. Preferred shareholders often have no voting power within the company, whereas common shareholders get a vote proportional to their level of ownership. This is most common when a company decides to elect a new board of directors or governing committee. As a general rule, preferred shares are safer than common stock but have fewer policies in place than bonds. While bonds are considered safer, particularly for interest rate hedging, preferred stock comes with a variety of other monetary benefits. This high-yielding format is one of the main reasons why investors select preferred shares.
Conclusion
The underlying difference between preferred stocks and common stocks is mainly the voting rights and dividend yield. This substantial monetary gain is often the reason why investors favour preferred shares.
When deciding between the two, the main question investors ask is whether the increased yield makes up for the loss of voting rights. Generally, if the investor is satisfied with how the issuing company is run, the answer is often yes, they will want preferred shares. However, in rare situations, shareholders’ voting power can have a significant impact on a company’s success. In that scenario, common stock might be viewed as a more appealing option.
Hopefully, this article gives you a better understanding of preferred stocks and why investors prefer them over common stocks. If you’re interested in understanding more about other business topics, feel free to let us know and we will cover it for you. If you’re looking for a loan consultant or interested to know more, click here and we would be pleased to assist you!
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