Preferred Stocks: Everything You Need to Know
Today, we’ll discuss a type of stock that isn’t as popular among individual investors, but is one of the favorite assets of investors like Warren Buffett.
Preferred stocks are issued by companies and come with mandatory dividends. They also have a date after which the company has the right to either redeem them or, less commonly, convert them into common stock.
Preferred stocks are a convenient investment instrument with greater security compared to common stocks. They have relatively low volatility and trade more like bonds than stocks.
The predictable dividends and principal security make preferred stocks a preferred choice for more conservative portfolios. This is precisely why they are included in the portfolios of major investors.
Preferred stocks have several characteristics that we’ll explain in more detail:
- Fixed Dividend: Unlike common stocks, where dividends can vary, preferred stocks offer a fixed dividend.
- Fixed to Float: For a set period, the stock pays a fixed dividend. After a certain date, the dividend transitions to a floating component, such as 3M Libor + 4.55% or the 5Y Treasury rate + 4.55%.
- Cumulative Dividend: If, for some reason, the dividend is temporarily suspended, it accumulates. In certain cases described in the prospectus, additional penalty interest may apply. While the preferred stock dividend is suspended, the company is prohibited from distributing dividends to common stockholders or repurchasing its own shares (buybacks).
- Non-Cumulative Dividend: If the dividend is suspended, it is not accumulated for future payment.
- Call Date: The date after which the issuing company has the right to redeem some or all of the shares at the issuance price.
- Mature Date: The date by which the company is obligated to redeem all preferred shares at their issuance price.
- Perpetual: Some preferred stocks have no maturity date, meaning they are not obligated to be redeemed.
- Convertible: The company may issue preferred stocks that can be converted into common stocks after a certain date.
Preferred stocks are a versatile financial instrument suitable for conservative investors looking for stability and predictable income.