One of the most significant advantages of preferred stock is that you are at the top of the list when it comes to dividend payments. This is a big deal if you are an income investor.
Advantages & Disadvantages of Preferred Stock over Common Stock
In the seniority of investors, the Preferred Stock Holder is higher than the Common Stock Holder.
This typically means:
- You Should get a higher fixed income from dividends in preferred stock, than those with common stock or even bonds. Great for the income investor.
- The price of preferred shares is typically lower than that of common shares.
- You will get less stock price fluctuation that with common shares, representing a more stable investment.
- You are the priority for Dividend Payments
However, the disadvantages are:
- No Voting Rights
- If the stocks are called back, you may miss some of the premium value in the stock
- More like bonds than stocks
- Limited Stock Price Appreciation, typically a preferred stock may fluctuate 10% up or down around the principle price; this is positive and negative. Positive for predictability, negative for price appreciation profits.
Preferred Stocks Mean Preferred Dividend Payments
The essential advantage here is that before the mass of common shareholders are paid their dividends, you will be paid. This means you are higher in the pecking order.
For most Preferred Stock as part of the conditions, they are nominated as cumulative preferred stock.
What Happens When the Dividend is in Arrears on Cumulative Preferred Stock?
Let’s take the following example. A utility company, “FreshWater Corp” has been paying dividends solidly for the last five years, but this most recent year has seen a downturn in profits, to the point where the FreshWater cannot pay a dividend.
For the next two years, the company works to turn around its business, and in the 4th year, it moves into a healthy profit.
FreshWater Co. then decides to reissue the dividend for shareholders at 5% Yield. Common Shareholders would receive 5%, but the preferred shareholders who typically would receive an annual yield of 6%, would have to be paid 24% before a single cent was paid to the common shareholders.
This is because FreshWater Co. was in arrears on its payments to the preferred cumulative shareholders.
This means the missed dividends to the Preferred Shareholders would accumulate over-time (in this case, four years) and have to be paid before anyone else.