Preferred stock is for those who wish a certain degree of priority in sharing in the earnings of a corporation at a stipulated rate. Preferred stocks are ownership shares with certain special rights; of these the principal one is that of receiving a specified dividend amount before the common shares receive anything at all. It is for this reason that many investors are attracted to this type of security.
There are various features of preferred stocks. First and foremost is the matter of the par value of each share. While $100 is fairly common, some corporations, such as industrial and utility, have felt that the investor of modest means would prefer something more nearly within his reach, so that values of $50, $25, and $20 have become more common; in a few cases we may find $10, $5, and even $1 par values. Sometimes there may be a preferred issue, which has no stated par value, but the return is definitely stated so that an assumed par value may easily be calculated. The market price will be in the neighborhood of this assumed value, depending upon the existing money rates and general business conditions.
The rate of return is based largely upon the projected earnings and also upon prevailing money rates. For example, during the Great Depression of the thirties, when money was scarce, it was quite common to issue 6 percent and even 7 percent preferred stocks. In recent years, when money has been more plentiful, many issues have had 4 percent, 42 percent, and 5 percent rates. Notwithstanding the stated rate of return, as in the case of bonds, the market price may cause the actual rate of return to be more or less than the stated rate; in other words, a preferred stock may sell at a premium or at a discount, depending upon the value placed upon it by the market place. However, there is one practical limitation placed upon such a price. In the case of an issue subject to call, that is, one that may be redeemed in whole or in part at the discretion of the directors, the call price may set an actual ceiling price on the stock, because no investor will be eager to buy a stock for more than the price at which it may be redeemed. This call feature is of no real value to the investor unless he has protected himself by buying the stock for something under the call price.
Preferred stocks usually have a provision for the regular payment of dividends, there usually being a statement, in effect, that regular quarterly dividends at the stated rate must be declared and paid upon the preferred stock before any payment may be made upon any stock of lower rank, such as the common. In case several series of preferred are outstanding, it is customary to give them a rank such that, for example, the class A has first preference, followed by the class B, and then the common.
An additional feature of most present-day preferreds is the cumulative provision, which means that if any dividends should be skipped, then such arrears must be paid up in their entirety before any payment may be made upon the common. Some companies place a limit upon the extent of cumulation, often restricting it to the extent to which it has been earned.