Preferred shareholders definition can be stated as the owners of stock who have priority on a company's assets. 

Basics of Preferred Stock

Preferred stock is a type of ownership that receives greater demand on a company's profits and assets than common stock. 

While preferred shareholders do not typically have a right to vote in the company, they do hold the benefit of being paid dividends before common shareholders. 

Features of preferred stock include:

  • Debt, which disburses dividends in a set amount
  • Equity, which has the ability for price growth

Overall, features of preferred stock vary with each issue.

There are two types of preferred stock:

A cumulative preferred stock requires any accumulated dividends be paid in full before a common stockholder can receive any dividend.

Preferred shareholders come before common shareholders concerning the issuance of dividends. In addition, preferred stock usually earns more than common stock and can be issued each month or in annual quarters. 

Dividend amounts can be either fixed or based on a minimum interest rate, such as LIBOR

Shares based on a flexible interest rate contain elements that alter the dividend payment like using the following to calculate further dividends:

  • Common stock dividends
  • A company's earnings

Preferred Stock and Struggling Businesses

Companies that are unable to pay dividends to shareholders of cumulative preferred stock will be required to pay the deficit of those preferred stock dividends before paying any amount of dividend to the shareholders of common stock.

Companies that have a lot of preferred stock outstanding may choose to prioritize the stock starting with prior stock as the highest level and following with a label preference of first, second, third, and so on. 

While preferred shareholders take priority over common shareholders in the event of a company liquidation, they come second to bondholders.

Technically, preferred stock is considered a type of equity; however, it resembles a combination of both bonds and stock.

Preferred shares are considered the less risky stock option for the following reasons:

  • The dividend issuance is more predictable.
  • Credit rating organizations provide ratings for the stock.

If a company is unable to pay out dividends to a preferred shareholder, the amount is accumulated until it can be paid in the future rather than placing the company in default.

The ratings on a company's preferred stock usually rank below the company's bonds because preferred shareholders do not have the same amount of assurance as bondholders.

Voting Rights, Repurchasing, and Conversion

Typically, preferred shareholders do not have any voting power through their stock; however, some contracts offer the power to claim voting rights when dividends are not issued.

Unlike the price of common stock, the price of preferred stock rarely rises and typically does not trade for more than a few dollars of the original purchase price, often $25. 

Factors that influence the price at which preferred stock is traded include:

  • The company's credit rating
  • Whether the stock is cumulative or non-cumulative
  • The stock's level of priority
  • Whether the stock is callable 

Callable shares permit the company to repurchase the stock at a given date for par value. 

For instance, if the rate of interest declines and the dividend payment has the ability to draw attention at a lower price, a company may choose to call, or repurchase, its stock and reissue it at a lower dividend yield. 

If a company chooses not to call its stock, the shares will remain in the market for trade. 

Occasionally, convertible preferred stock is issued allowing the shareholders to exchange the stock, in the proper situation, for a certain amount of common stock.

Three possibilities of stock conversion are as follows:

  • The board of directors can choose to convert shares.
  • The investor can choose conversion.
  • The stock may include a set date of automatic conversion. 

The current market price of a company's common stock determines whether the investors will benefit from a stock conversion. 

The types of preferred stock previously mentioned are merely the most widely issued forms; ultimately, preferred stock can be established in many different ways utilizing a mix of different features. 

Provided no laws or regulations are broken, a corporation can sell preferred stock containing just about any type of conditions. 

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