How Do Preferred Shares Work?
Shares of stock represent an ownership percentage in a corporation. If a corporation has 100 shares of stock, a person holding 25 shares owns 25 percent of that corporation. Stock can have different characteristics. Preferred stock offers fixed dividends along with some preferential treatment over common stock.
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Common Stock
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Most individual investors own common shares of stock. For publicly traded corporations, the price of common shares generally varies depending on the market. Investors that buy shares of stock when the price is low can sell those shares later when the price is high and recoup the investment. Common shares also entitle the holder to vote in elections held to elect the board of directors. If the corporation goes bankrupt, holders of common shares are the last people paid after creditors, bond holders and preferred stock holders.
Preferred Stock
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Preferred shares of stock also represent an ownership interest in the company, but they differ from common stock. Preferred stocks pay out a fixed dividend (provided the company has ample resources to do so). The fixed dividend is often higher than any dividend offered on the corporation's common stock (corporations may choose to pay out dividends on common stock but do not have to). Holders of preferred shares do not have voting rights.
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Preferential Treatment
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As the name suggests, preferred stock offers a degree of preferential treatment. Holders of preferred stock are entitled to a fixed dividend. If the corporation offers dividends on common stocks, dividends must first be paid to holders of preferred shares before the common shareholders take their cut of the profits. If the corporation must liquidate its assets, preferred stockholders have priority over common stockholders.
Various Features of Preferred Stock
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Corporations can structure specific features into preferred stock. Preferred stock may be cumulative, for example. This means that if a corporation failed to pay dividends in previous years (most often because the corporate profits were low), the cumulative preferred stocks accumulate the prior dividends and are paid when the corporation has sufficient cash flow to do so. Preferred stock can also be convertible, meaning that preferred stockholders can trade in preferred stock for a certain amount of common stock. Other options are available; speak to a financial investment expert when contemplating a preferred stock investment.
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