Preferred Shares Definition

Preferred shares are a type of company share, which can be thought of as a hybrid security – in other words, a combination between a stock and a bond. In the event of a company’s liquidation, they are considered senior to regular stocks as a claim to the company’s assets – indeed, this is considered their main advantage – but still inferior to bonds, the safest investment. Like common shares, they confer partial ownership of a company, and indeed, they may frequently be converted to the former at the discretion of the holder. However, they bestow special rights to holders which common stocks do not, which may include preference in dividends (known as ‘cumulative preferred shares’, where missed dividend payments, ‘arrears’, build cumulatively). This dividend, unlike common stocks, is often fixed (does not fluctuate), and preferred shareholders will always receive their dividend payment first, though a company does still have the right not to pay it in the event of financial difficulty. On the other hand, preferred stocks usually do not confer voting rights, and may at any time be called at the option of the corporation.

Holders of preferred stocks usually sacrifice higher potential returns for investment security as preferred stock is generally much less volatile compared to common stock. If a given company were to make a huge breakthrough – for example, a pharmaceutical company were to discover a miracle cure for cancer (here’s hoping!) – their common shares would rocket through the roof as bullish buyers flock, netting incumbent investors a sizeable profit if they choose to sell. Preferred shares probably wouldn’t budge to the same extent, meaning their holders will forgo the golden opportunity to cash in. However, if that cure were later to prove ineffective, preferred stakeholders will be the ones smiling, as common stocks plummet while their holdings remain stable. In other words, preferred stocks are usually an option for the more risk-averse investor. They are less volatile, but offer less option for speedy reward as a result.

Did you find this preferred shares definition helpful? Subscribe to our spam-free newsletter to receive regular financial definitions, updates on our latest articles, plus exclusive annotated market reports.