Ep 7: What is a Preferred Stock?

Welcome back to another episode of Market MakeHer, the podcast where we dive deep into the world of finance and empower women to take control of their investments. In today's episode, we explore a fascinating type of stock that you may not have heard much about: preferred stocks. Follow us down the rabbit hole of Preferred Stocks and the benefits of potentially including them in your portfolio. Imagine, a common stock and a bond had a baby, but with the complications and nuances of a mutual fund, and you’ve got a preferred stock. Join us as we unravel the complexities and shed light on how preferred stocks work and why they are worth considering for your investment portfolio.

Episode Equity

Demystifying Preferred Stocks

What Are Preferred Stocks? A Simple Explanation:

Let's start with the basics. You're already familiar with common stocks, which represent ownership in a company. Preferred stocks, on the other hand, are hybrid investment vehicles that blend characteristics of both stocks and bonds. Think of them as the offspring of a common stock and a bond. They offer the interest of a bond while acting like a stock, providing investors with a unique set of benefits.

Understanding Dividends and Yield:

To grasp the potential earnings from preferred stocks, it's crucial to understand how dividends and yields work. Dividends are regular payments made by a company to its shareholders. In the case of preferred stocks, these dividends are often higher than those of common stocks. The dividend yield is expressed as a percentage of the stock's current value. However, it's important to note that the yield fluctuates with the stock price, so it's not a fixed amount.

The Anatomy of Preferred Stocks:

Preferred stocks have a par value, similar to a face value for bonds, which determines the principal amount of the investment. Unlike common stocks, preferred stocks come with a predetermined par value, usually lower than that of bonds. This par value guarantees that you will receive the principal amount when the preferred stock matures. Furthermore, preferred stocks can have various classes, each with different features, dividend rates, and ticker symbols.

Risk, Stability, and Convertibility:

While preferred stocks are less volatile than common stocks, they still hold a certain level of risk. They fall in the middle of the risk scale between common stocks and bonds. However, their stability makes them appealing to investors who prefer a more predictable income stream. Additionally, some preferred stocks offer the option to convert them into common stocks within a specific time frame, providing further flexibility.

Company Credit Scores and Investment Grade:

Did you know that companies also have credit scores? Just like individuals, companies have ratings that indicate their creditworthiness. A good credit score for a company is typically BBB or higher. When considering buying preferred stocks, it's important to check the company's credit score to assess the reliability of their debt obligations.

At Market MakeHer, our mission is to empower you to achieve financial independence. Preferred stocks offer a unique avenue for diversifying your portfolio and generating a stable income. We encourage you to explore the potential of preferred stocks and how they can fit into your investment strategy.

Jessie's Questions

  • Q: What is a preferred stock?
  • A: Preferred stock is a hybrid investment between a bond and a stock, giving it characteristics of both. It is issued at a face value, such as $25.00 that it generally trades relatively close to.
  • Q: How does a preferred stock differ from a common stock?
  • A: Preferred stock provides a fixed dividend yield and has a higher priority in receiving dividends compared to common stock and have a
  • Q: What is the dividend yield for preferred stocks?
  • A: The dividend yield for preferred stocks is fixed and is typically higher than that of common stocks.
  • Q: Can preferred stocks be converted into common stocks?
  • A: Yes, preferred stocks can be converted into common stocks within a specified time frame.
  • Q: Why would a beginner investor consider investing in preferred stocks?
  • A: Preferred stocks are considered less risky, provide stable income, and are a good option for those looking to build an income-focused portfolio.
  • Q: How do preferred stocks compare to bonds?
  • A: Preferred stocks are less risky than common stocks but riskier than bonds. They offer a middle ground between the two in terms of risk and potential returns.
  • Q: Do preferred stocks have credit ratings?
  • A: Yes, preferred stocks, like companies, can have credit ratings that indicate their creditworthiness.
  • Q: What should investors consider before investing in preferred stocks?
  • A: It is important to assess the credit rating of the company issuing the preferred stock and understand the terms and conditions of the investment.

Episode Transcript

Jess: Hello market makers! Welcome back to another episode of Market Make Her. I'm your finance expert, Jess Inskip

Jessie: And I'm Jessie DeNuit, your guide on this financial empowerment journey. Today, we're taking a deep dive into another type of stock that you may or may not have heard about. I know this is a new one for me personally.

Jess: That's right, Jessie. We're talking about preferred stocks. A company can issue more than one type of stock.

Jessie: So, can you explain to me and the listeners what a preferred stock is in simple terms?

Jess: Absolutely! So the stocks that we have been talking about are what is called Common Stocks. A company will issue common stock to raise capital once done with their infancy stages. Venture capitalists are cashing out at that point. A preferred stock it's actually a hybrid investment vehicle between a bond and a stock so they issue it again to raise more Capital but it works completely different. Is there any jargon that I need to explain so far?

Jessie: Well I said in simple terms.

Jess: I realized I didn't even do that

Jessie: I'm going to ask you again what a preferred stock is in simple terms because what would the simple answer be a bond and a stock together?

Jess: Yeah, it's like a common stock and a bond had a baby they would produce a preferred stock gives you interest of a bond but it acts like stock.

Jessie: Okay so a common stock is just like the regular stocks that we've already talked about in our what is a stock episode?

Jess: Yes, that's right. A preferred stock is if a common stock and a bond had a baby, and that's a preferred stock.

Jessie: Okay, so now what does this baby look like?

Jess: Not cute! Let's use AT&T (T) as an example. They are known for having one of the best dividends out there. Their dividend is about 7%. They trade on the secondary market, and their 52-week high and low are $21.39 and $14.46, respectively. Currently, they are around $16, and that dividend yield is based on $16.

Jessie: That's a good point. When a stock gives you a dividend and their dividend yield is 7%, it's 7% of whatever the stock value is at that moment. The annual dividend amount is divided by the previous day's closing price. So, the yield can change day to day.

Jess: Exactly! AT&T is an income-producing security. They pay their dividends quarterly, about $0.28 per quarter. That's $1.11 per year based on their closing price of $15.95. So, the yield is 6.96%.

Jessie: Got it. So, they pay dividends based on their stock's current value. But there's a different type of income stock, which is a preferred stock.

Jess: Right. A preferred stock has a par value, just like a bond. It's a considerably lower par value, usually $25. The company is required to pay dividends to preferred stockholders before paying common stockholders. AT&T has multiple preferred stocks, and each has different features and ticker symbols.

Jessie: So, why do people buy preferred stock? What's the benefit?

Jess: The benefit is the face value part, the dividend yield. Preferred stockholders have a higher chance of receiving their income. It's considered an obligation, a debt security. Preferred stocks normally have higher dividend payments. If the company goes under, preferred stockholders have higher preferential treatment.

Jessie: Ah, so they get preferential treatment and get paid out before everyone else who owns the stock. It's a bit more stable in the stock market than common stock, right?

Jess: That's correct. Preferred stock falls in between common stock and bonds on the risk scale. It's less risky than common stock but not as riskless as a bond.

Jessie: Right, but there's another important part of preferred stock to talk about. They can also be issued as convertible, right?

Jess: Yes, that's right. Preferred stock can be converted into common stock within a certain time frame. If you own preferred stock and want to convert it into common stock, you have that option.

Jessie: Wow, it seems like preferred stocks have their own complications and nuances. But if you're a beginner investor or looking for a less risky option, preferred stock might be worth considering. It's a way to have an income portfolio without tying up your money in a bond.

Jess: Exactly! Preferred stocks are great for income portfolios and offer stable income with higher dividend payments. They are less volatile than common stocks and can be a good addition for investors seeking income.

Jessie: It's important to keep learning and expanding our knowledge. Thank you all for joining us on this journey into preferred stocks. Remember, the more you learn, the more you can potentially earn. Knowledge is the cornerstone of financial empowerment.