Preferred Stock

Preferred stock is a form of equity security. A corporation issues stock to raise capital by giving investors an ownership stake in the company proportionate to the amount of stock they own. Usually the stock offers a regular fixed payment in the form of a dividend. Preferred stock is often referred to as a hybrid security because it offers the regular fixed income of a bond but also the ownership stake in a company in the form of common stock.

Income Stream

Preferred stock has a fixed dividend payment, but a corporation can choose to skip the payment to preferred stockholders if the company is in financial trouble. Bond interest payments are backed by the force of law, which requires the issuer to pay or face bankruptcy. Because of this distinction, bonds offer a more reliable income stream than preferred stock.

Obligation to Pay

Debt obligations take precedence over all other obligations a company has. Before dividends are paid to either preferred or common stockholders, interest on bonds must be paid. In the event of bankruptcy, bondholders again take precedence, and are usually able to collect some percentage from the liquidation of the company’s assets. Shareholders may be left with little or no compensation. Bonds offer a more secure return on investment because of the seniority of debt obligations.

Risk

If a company fails to make a profit, preferred stockholders may see their dividends suspended. The value of the stock may fluctuate in value due to market risk. With bonds the primary risks are interest rate fluctuation and risk of default. An increase in interest rates makes a bond less valuable. A bond issuer may default if unable to meet its debt obligations. In this case the bondholder would not receive his interest due, although he may be able to recoup some of his losses from bankruptcy proceeds.

Flexibility

References

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