Understanding Preferred Stock: A Hybrid Security Explained

Preferred stocks combine features of common stocks and bonds.

Preferred stock is a hybrid security because it combines features of common stocks and bonds. At the same time, it has several unique features that set it apart from both.

Common Stock Features

Preferred stock represents partial ownership in a corporation and pays quarterly dividends.

Bond Features

Preferred stock pays high current income (although in the form of dividends) and can be called (redeemed) at par (face value) under certain conditions. Some preferred stocks are convertible to common stock under certain conditions.

Unique Features

Preferred stockholders do not have voting rights. Common stocks are perpetual securities, whereas most preferred stocks have call dates. Preferred stocks can be cumulative (entitling its holder to any dividends and arrears), whereas if dividends on common stocks are suspended or omitted, common stockholders have no recourse.

Unlike bond interest, preferred dividends can be omitted or suspended without triggering default provisions.

Worst of Both Worlds

Preferred stocks have limited upside potential because of the call feature. Bonds have a priority claim over preferred stocks against corporate assets in bankruptcy or liquidation.