How to Convert Preferred Stock
Preferred stock are so-named because they offer benefits to their owners beyond common stock. Primarily the advantages of preferred stock are a higher dividend yield and a more superior position in a company's debt structure. On the other hand, preferred stock often carry little or no voting rights, and, though they can trade publicly, are usually less liquid than the common stock. Some, but not all, preferred shares can be convertible, meaning the owner can swap their preferred for common stock. Because this is usually done at a fixed ("par") value, the conversion can increase the investor's total return by providing capital gains on top of previously received fixed income.
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Instructions
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Pass the conversion date. Assuming the preferred stock is convertible, it might nevertheless be subject to timing restrictions on its convertibility. This so-called "conversion date" sets a fixed point in the future at which the preferred shares are eligible for conversion. Convertible preferred shares are not convertible prior to the conversion date, if such a restriction is placed upon the shares.
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Find the conversion ratio. A convertible preferred share can have a 1:1 ratio, meaning it's exchangeable directly for a share of common. More likely, however, the ratio will be some multiple, with preferred share often being convertible into three or five shares of common. The conversion ratio is crucial for determining whether it is financially advantageous to convert the preferred stock, and will be provided by a broker facilitating the transaction of preferred stock.
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Calculate conversion premium. The conversion premium is the difference between the market value of the converted shares less the value of the unconverted preferred shares. If this is a positive, it represents a potential capital gain (profit) called the conversion premium. For example, if a preferred share is trading at $20 and is convertible into five shares of common stock, there would be a positive conversion premium if the common stock is trading above $4. If the stock is trading at $5, there is a conversion premium of $5, since ($5x5) - $20= $5. Without a conversion premium, there is little incentive for the owner of a preferred share to convert and forgo the preferred share's other benefits.
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Contact broker. The process of converting preferred shares into common stock involves returning the preferred shares to the issuing company in exchange for the common shares. This, however, is handled by the owner's licensed broker. Simply contacting the broker and informing them of the intention to convert is enough to get this process started.
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Tips & Warnings
There are many different types of preferred and convertible preferred shares. Be familiar with the specific details of your preferred shares, especially the dividend rate, conversion date, and conversion provisions.
In addition to being convertible by the owner, some preferred shares can be "callable," meaning they can be converted by the issuing company. The terms of the company's right to call back preferred shares is usually limited in time and price to protect the owner of the preferred shares from loss, but called shares might not produce the capital gain that might otherwise be achieved.
