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Is there a Difference?

What is the Difference?

By Dr. David Edward Marcinko MBA CMP®

SPONSORED: http://www.CertifiedMedicalPlanner.org

A common stock is the least senior of securities issued by a company. 

A preferred stock, in contrast, is slightly more senior to common stock, since dividends owed to the preferred stockholders should be paid before distributions are made to common stockholders. 

However, distributions to preferred stockholders are limited to the level outlined in the preferred stock agreement (i.e., the stated dividend payments).  Like a fixed income security, preferred stocks have a specific periodic payment that is either a fixed dollar amount or an amount adjusted based upon short-term market interest rates. 

However, unlike fixed income securities, preferred stocks typically do not have a specific maturity date and preferred stock dividend payments are made from the corporation’s after tax income rather than its pre-tax income.  Likewise, dividends paid to preferred stockholders are considered income distributions to the company’s equity owners rather than creditors, so the issuing corporation does not have the same requirement to make dividend distributions to preferred stockholders. 

So, preferred stock is generally referred to as a “hybrid” security, since it has elements similar to both fixed income securities (i.e., a stated periodic payments) and equity securities (i.e., shareholders are considered owners of the issuing company rather than creditors). 

Convertible preferred stocks (and convertible corporate bonds) are also considered hybrid securities since they have both equity and fixed income characteristics.   A convertible security whether a preferred stock or a corporate bond, generally includes a provision that allow the security to be exchanged for a given number of common stock shares in the issuing corporation. The holder of a convertible security essentially owns both the preferred stock (or the corporate bond) and an option to exchange the preferred stock (or corporate bond) for shares of common stock in the company. 

ASSESSMENT: Thus, at times the convertible security may behave more like the issuing company’s common stock than it does the issuing company’s preferred stock (or corporate bonds), depending upon how close the common stock’s market price is to the designated conversion price of the convertible security.

CITATION: https://www.r2library.com/Resource/Title/0826102549

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Filed under: CMP Program, Financial Planning, Investing, Touring with Marcinko | Tagged: common stock, preferred stock |