In many respects, publicly held corporations are the ultimate democratization of wealth. Both the Sultan of Brunei and your neighborhood plumber can buy however many shares they want of, say, Cisco Systems, Inc. (CSCO), the only barrier to entry being the outlay of a few bucks to create an E*Trade Financial Corp. (ETFC) account.
Sometimes, a corporation wants to lure a certain class of investor; the kind who wants fixed, scheduled payments. To do that the company can issue bonds, which come with their own disadvantages. When a company authorizes a bond issue it could be declaring that it’s desperate for cash, which can scare stock investors off. How to offer equity while simultaneously guaranteeing investors a certain regular payment? Through the magic of preferred stock, which is sort of an amalgam of bonds and common stock. (For more, see: A Primer on Preferred Stock.)
The differences between preferred stock and common stock are few but crucial. Preferred shareholders indeed receive dividend payments: the dividends are a selling feature, intrinsic to the security. Whereas with common stock, corporations are under no obligation to offer dividends. (For more, see: What is the Difference Between Preferred Stock and Common Stock?)
Becoming Rare
In practice, the blue-chip companies that offer dividends on their common stock don’t issue preferred stock, at all. Seldom do the companies that don’t offer dividends on their common stock, either. Preferred stock is a dying class of share. According to some estimates, there’s $80 of common stock circulating in the United States for every dollar of preferred stock. None of the heavyweights – Apple Inc. (AAPL), Exxon Mobil Corp. (XOM), Microsoft Corp. (MSFT), etc., offer preferred stock. Among the 30 largest corporations in America by market capitalization, the only ones that do offer preferred stocks are the Big Four banks – Wells Fargo & Co. (WFC), Bank of America Corp. (BAC), Citigroup Inc. (C) and JPMorgan Chase & Co. (JPM). In fact, about 88% of preferred stock is issued by banks. As to why, it’s the continuation of the aftermath of the financial crisis and corresponding bailouts of 2008-09. Preferred stock becomes an additional asset on the balance sheet, something that banks need more than oil companies and semiconductor manufacturers do. (For more, see: Preferred Stock Features.)
No Voting Rights
Most things in life involve a tradeoff, and preferred stock is among them. From an investor’s perspective, the one primary disadvantage to preferred stock is that its holders don't have voting rights. Just from the name, you’d figure preferred stockholders would receive, well, preferential treatment. But when a company elects board members, it’s the common stockholders who do the electing while the preferred stockholders sit on the sidelines, disenfranchised. (For more, see: Know Your Rights as a Shareholder.)
Better During Bankruptcy
On the other hand, say the publicly traded company goes bankrupt. When the company liquidates, the bondholders get paid first. Which makes sense; they’re the creditors, the ones who lent their money to the company to help it stay afloat. Should there be anything left once the bondholders get made whole, the preferred shareholders get paid next. Only then do the common stockholders get paid, if at all. Thus the “preferred” in preferred stock.
There are some other differences between preferred and common shares, too. The latter can be called by the company at its discretion. “We reserve the right to buy these shares back from you on May 17, 2016.” In most cases, you can convert the preferred shares to common shares at a predetermined rate. Do that, and you’re sacrificing surety for volatility and the possibility of capital appreciation.
Alright, enough theory. Say you wanted to buy preferred stock. Assuming you indeed opened a brokerage account like the plumber in our example, how would you even start?
Finding Preferred Stock
First, how to read a preferred stock listing. They differ from common stock listings, which are easy to read. International Business Machines Corp. (IBM) common stock (the only kind the company offers) is listed on the ticker under a 3-letter code: IBM. Boom, give me a hard one.
Preferred stocks are more complicated. Because the dividend payments are so important, preferred stocks are defined by their dividends (expressed as a percentage):
Symbol | Name | Price on 10/11/14 |
SSW-E | Seaspan Corp. (SSW) 8.25% Cumulative | $24.95 |
SCE-B | Southern California Edison 4.08% | $21.04 |
SCE-C | Southern California Edison 4.24% | $21.25 |
SCE-D | Southern California Edison 4.32% | $22.80 |
ZB-A | Zions Bancorp (ZION) Floating Rate (minimum 4%) | $24.60 |
Pretty straightforward, no? The ticker symbol includes a one-letter suffix indicating that the stock is preferred. It’s a good thing the Roman alphabet has 26 letters, because a company can issue various classes of preferred share, which is why we included three different Southern California Edison preferred issues in our example.
Treated Like Bonds
Nor is it coincidence that all the issues are at about the same price. With very few exceptions, preferred shares go on the market at $25. That they don’t stray much from that price tells you how the market treats them almost like bonds. No one’s going to offer much more than $25 for a share that could be called, and no one’s going to sell so valuable a revenue-producing asset for much less than $25. By the way, that issue price is also the price that the company will call the share at, should it choose to. (For more, see: Why do Some Preferred Stocks Have Higher Yield than Common Stocks?)
Understandably, the higher the dividend rate, the more expensive the stock. Buy a share of Southern California Edison 4.08%, and you’ll receive quarterly dividend payments that would each amount to 25.5¢. The quantity the dividend is expressed as a percentage of is the issue price (again, $25).
A couple more points. “Cumulative,” as in Seaspan 8.25% Cumulative preferred stock, means that if the company hadn’t paid out a particular dividend in the past, that dividend accumulates until it is paid out. And it’ll be paid out before the common stockholders get any dividend. In Seaspan’s case, the company does pay a quarterly— if erratic— dividend to its common shareholders and has for years. “Floating rate” means the dividend payout changes according to criteria determined by the issuer. In Zion Bancorporation’s case, the rate is tied to the London Interbank Offered Rate. (For more, see: Preferred Stock Valuation.)
The Bottom Line
Among intermediate and advanced securities, preferred stocks carry a relatively small learning curve and less chance of risk. You’re less likely to go bankrupt with preferred shares than with common shares. So should you invest in them? Understand that most preferred shareholders are institutional: organizations that have little to gain and much to lose by putting their funds in anything less stable than a bond or bond equivalent. For the everyday investor, buying preferred shares is usually something done once you’ve already established a decent-sized portfolio. One that was probably, at least in part, the result of buying undervalued common stocks. If you're still interested, though, consider a preferred stock exchange-traded fund (ETF). (For more, see: Preferred Stock ETFs With Huge Dividends.)
As a financial expert with a deep understanding of investment instruments and corporate finance, I can provide comprehensive insights into the concepts mentioned in the article. My expertise is rooted in practical knowledge and extensive research within the financial domain.
The article discusses publicly held corporations, wealth democratization, and the role of preferred stocks in the investment landscape. Let's break down the key concepts:
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Publicly Held Corporations:
- Publicly held corporations are companies whose shares are traded on the open market.
- Individuals, regardless of their financial status, can buy shares in these corporations.
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Democratization of Wealth:
- The article suggests that buying shares in publicly held corporations allows individuals, ranging from the Sultan of Brunei to a neighborhood plumber, to participate in wealth creation.
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*Equity Investment and ETrade Financial Corp. (ETFC):**
- The article mentions E*Trade Financial Corp. as a platform for creating accounts to buy shares, emphasizing the accessibility of equity investment.
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Bonds vs. Preferred Stock:
- Corporations issue bonds for fixed, scheduled payments, but this may signal financial desperation.
- Preferred stock is introduced as a hybrid between bonds and common stock, offering regular payments with equity participation.
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Preferred Stock vs. Common Stock:
- Preferred shareholders receive dividend payments, providing a certain level of income.
- Common stockholders have no guarantee of dividends.
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Popularity and Issuers of Preferred Stock:
- The article notes that preferred stock is becoming rare, with blue-chip companies and major tech companies typically not offering it.
- Banks, especially the Big Four, are the primary issuers of preferred stock, comprising around 88% of the market.
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Voting Rights and Bankruptcy:
- Preferred stockholders lack voting rights, unlike common stockholders.
- In the event of bankruptcy, preferred stockholders are prioritized after bondholders but before common stockholders in terms of payment.
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Characteristics of Preferred Stock:
- Preferred stocks are often priced around $25, similar to bonds.
- The article explains the significance of the cumulative and floating rate features in certain preferred stocks.
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How to Buy Preferred Stock:
- The article briefly touches on how to read a preferred stock listing and highlights that preferred stocks are defined by their dividends.
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Preferred Stock ETFs:
- The article suggests that investing in preferred stock ETFs might be a suitable option for everyday investors interested in this asset class.
In conclusion, the article provides valuable information on the democratization of wealth through publicly held corporations and delves into the unique characteristics of preferred stocks as an investment option. The insights offered are in line with practical knowledge and industry trends, reinforcing the expertise demonstrated in this analysis.
