Preferred Stock Conversion to Common Stock

Convertible preferred shares can help investors build wealth.

Preferred shares are generally described as conservative investments that pay large dividends. Convertible preferred shares, however, are hybrid securities that combine characteristics of both preferred and common shares. These transactions do carry distinct risks.

Benefits

Preferred share conversion allows you to participate fully in the long-term gains associated with common stock.

Strategy

Preferred stock may be convertible into a set number of shares of common stock. You will decide to convert when prices for the common shares exceed parity relative to preferred share values. For example, your preferred stock could carry provisions that allow you to exchange one preferred share for 10 common shares. If preferred shares trade for $100, you will benefit from conversion when common shares trade above $10.

Features

Convertible preferred shares are sometimes linked with poison pills that deter hostile takeovers. Poison pills enable convertible preferred shareholders to trade their position for large amounts of common stock, as one investor exceeds a set ownership percentage of the corporation.

Considerations

Convertible preferred shares generally pay lower dividends than straight preferred stock. Investors are willing to accept less dividend income for the conversion privilege.

Warning

Convertible preferred shares are more volatile than straight preferred stock. Convertible preferred shares lose significant value when associated common stock prices fall.

References

• Investopedia: Introduction to Convertible Preferred Shares
• Investopedia: Preferred Stock
• Investopedia: Common Stock

Resources

• Investopedia: Stock Basics
• IRS: Corporations
• Investopedia: Dividend