Is Preferred Stock Equity or a Fixed-Income Security?

Preferred stock is equity. Its shares represent an ownership stake in a company just like common stock but preferred stock normally has a fixed dividend payout as well. Some call preferred stock a stock that acts like a bond.

It’s a bonus when the owners of common stock shares get dividends but it’s a steady income stream if they hold preferred shares. These shares are issued with a set dividend that must be paid before the company’s board considers any dividend for common shareholders.

This set dividend rate effectively makes it a fixed-income security. Purchasers of preferred stocks tend to be looking for a regular income supplement and they usually intend to hold onto the shares for a long time.

Key Takeaways

• Preferred stocks are equity investments just like common stocks.
• Preferred stocks yield a set dividend that must be paid in preference to any dividend paid to owners of common stock.
• Preferred stocks can be purchased for their regular income payments, not their market price fluctuations.
• The dividend rate is set but it may be adjustable.

Adjustable-Rate Preferred Stocks

The dividend rate is set but it may be an adjustable rate. A preferred stock issue may have a dividend that’s tied to a particular benchmark interest rate. This makes their market prices less sensitive to interest rate changes and protects the shareholder from losing the real spending power of the income.

Examples of Preferred Stocks

Preferred shares are most often issued by companies that are well-established and have a steady revenue stream. The prices of their stocks aren’t necessarily growing or dropping by leaps and bounds. The company is solid.

Important

There are many ETFs for preferred stocks. Some specialize in financial preferred shares or global preferred shares.

Utility companies may be the best examples of companies that issue preferred stocks. Financial services companies including Goldman Sachs and JPMorgan Chase issue preferred shares, too, however, as do some real estate investment trust companies including EPR Properties and Digital Realty Trust.

Many exchange-traded funds (ETFs) focus on investing in dividend-paying preferred stocks as well. The top picks in a U.S. News & World Report analysis included Invesco Preferred ETF, the VanEck Vectors Preferred Securities ex Financials ETF, and the Invesco Financial Preferred ETF.

One More Benefit

There’s one additional benefit of preferred stock. Its preferred stockholders must be repaid before common stockholders if a company goes into liquidation. The chances of reimbursement aren’t good, however. Even preferred shareholders are in line for payment behind all the creditors and company bondholders.

Disadvantages of Preferred Stocks

Buyers of preferred shares generally intend to own them for the long term. They’re bought and sold the same way as common stocks but they’re never going to be the hot stocks of the day.

Their prices do rise and fall with the rate of inflation, particularly if the dividend doesn’t have an adjustable rate.

What Is an Exchange-Traded Fund (ETF)?

Exchange-traded funds (ETFs) trade on exchanges, as the name implies. This sets them apart from mutual funds but both involve purchasing into a fund that makes and maintains investments in bonds and stocks. ETFs tend to make fewer capital gains distributions so this gives them a slight edge taxwise.

How Does Investing in Bonds Work?

Companies and governments issue bonds to bring in money. They’re effectively loans made by investors. You purchase the bond and are promised repayment on a set maturity date plus interest that’s paid out periodically. Treasury bonds are guaranteed by the U.S. government.

What Are the Advantages of Holding Common Stock?

You become a partial owner of the company when you invest in common stock. Your ownership percentage is commensurate with the amount of stock you purchase. It gives you voting rights on important company decisions and it also guarantees you a percentage of the company’s profits. Your share of profits isn’t generally paid to you in cash although some companies do pay dividends.

The Bottom Line

Preferred stocks are equity investments. They’re often issued by well-established companies so they tend to be safe and secure investments over the long term. They generally pay dividends and these payments are preferential in order of repayment over common stock issues in the case of the company’s financial distress or liquidation.

Talk to an advisor about your investment goals and needs to find out if these stocks are right for you.