Preferred Stock vs Common Stock
When investors refer to "buying stock," they almost always mean common stock. These are the shares listed on exchanges, quoted in financial news, and held in most brokerage accounts. But corporations can issue another class of equity called preferred stock, which occupies a distinct position in the capital structure between common stock and corporate bonds. Preferred stock has characteristics of both equity and debt, and understanding the differences between preferred and common shares matters for income investors, bank stock analysts, and anyone evaluating a company's capital structure.
Common Stock: Ownership With Upside and Risk
Common stock represents residual ownership in a corporation. Common shareholders are last in line for everything: dividends (after bondholders and preferred shareholders), assets in a liquidation, and claims on cash flow. In exchange for being last, common shareholders have unlimited upside. If the company grows its earnings tenfold, common shareholders capture that value through share price appreciation and growing dividends.
The characteristics of common stock are familiar to most investors:
Voting rights. Common shareholders typically receive one vote per share on corporate matters including board of director elections, major acquisitions, and executive compensation packages. Voting power is proportional to share ownership.
Dividends. Common stock dividends are not guaranteed. The board of directors declares them at its discretion, and they can be increased, reduced, or eliminated at any time. During the 2020 pandemic, dozens of major companies cut or suspended their common dividends, including Royal Dutch Shell, Disney, and Boeing.
Price appreciation. The primary source of returns for most common stock investors is price appreciation driven by earnings growth, multiple expansion, or both. Apple's common stock returned more than 1,000% from 2014 to 2024, almost entirely through price appreciation.
Residual claim. In a bankruptcy or liquidation, common shareholders receive whatever is left after all creditors, bondholders, and preferred shareholders have been paid. In practice, this is often nothing. In the Lehman Brothers bankruptcy, common shareholders recovered zero.
Preferred Stock: The Hybrid Security
Preferred stock sits between common stock and bonds in the capital structure. It has features of both and is fully neither. The name "preferred" refers to its priority over common stock in receiving dividends and in liquidation, not to its superiority as an investment.
Fixed dividends. Most preferred stocks pay a fixed dividend, expressed either as a dollar amount per share or as a percentage of par value. A preferred stock with a $25 par value and a 6% coupon pays $1.50 per year ($0.375 per quarter). This dividend is fixed, similar to a bond coupon, and does not increase when the company's earnings grow.
Dividend priority. Preferred dividends must be paid before any common dividends can be declared. If a company's board decides to pay dividends, it must satisfy the preferred dividend obligation first. However, preferred dividends are not a contractual obligation like bond interest. The board can choose to skip preferred dividends (with consequences discussed below).
No voting rights (usually). Most preferred shares do not carry voting rights. The preferred shareholder accepts a more predictable income stream in exchange for giving up the ability to influence corporate governance. Some preferred issues grant voting rights after a certain number of missed dividend payments.
Limited upside. Because the dividend is fixed, preferred stock has limited price appreciation potential. If a company's earnings double, the preferred dividend stays the same, and the preferred stock price will not reflect the earnings growth. Preferred stock trades primarily based on interest rate movements and credit quality, much like a bond.
Liquidation preference. In a liquidation, preferred shareholders are paid before common shareholders but after bondholders and other creditors. The preference is typically the par value of the preferred stock plus any accrued unpaid dividends.
Types of Preferred Stock
The preferred stock universe includes several variations, each with different features.
Cumulative preferred. If the company skips a dividend payment, the missed payments accumulate and must be paid in full before any common dividends can resume. Most preferred stocks are cumulative. This feature provides protection against temporary dividend suspensions but does not guarantee that the dividends will ever be paid if the company remains in financial distress.
Non-cumulative preferred. Missed dividends are gone permanently. If the company skips a quarterly payment, that payment is never made up. Non-cumulative preferred offers less protection but is common among bank-issued preferred stocks.
Convertible preferred. These can be converted into a specified number of common shares at the holder's option, typically at a predetermined conversion ratio. Convertible preferred combines the income certainty of preferred stock with some participation in common stock upside. If the common stock price rises above the conversion value, the preferred stock price will track the common stock. If the common stock declines, the preferred stock is supported by its fixed dividend yield. Companies like Uber and Lyft issued convertible preferred to venture capital investors before their IPOs.
Callable preferred. The issuing company can redeem the preferred stock at a specified price (usually par value) after a specified date. This limits the investor's upside: if interest rates decline and the preferred stock trades above par, the company can call it at par, forcing the investor to reinvest at lower yields. Most preferred stocks issued by financial institutions are callable after five years.
Adjustable-rate preferred. The dividend rate resets periodically based on a benchmark interest rate, typically the Treasury rate or SOFR. This reduces interest rate risk but also means the income stream is not fixed.
Perpetual preferred. Has no maturity date. The preferred stock stays outstanding indefinitely unless the company redeems it (if callable) or converts it (if convertible). This exposes the investor to long-duration interest rate risk.
Who Issues Preferred Stock
Financial institutions are the dominant issuers of preferred stock. Banks, insurance companies, and REITs issue preferred shares because regulators often count preferred stock as Tier 1 regulatory capital, which strengthens the institution's capital ratios without diluting common shareholders' voting power.
JPMorgan Chase has more than $30 billion in preferred stock outstanding across multiple series. Bank of America, Wells Fargo, Goldman Sachs, and Morgan Stanley each have substantial preferred stock programs. For these institutions, preferred stock is a cost-effective way to maintain regulatory capital buffers.
Utilities and REITs also issue preferred stock to fund capital-intensive operations. These sectors have relatively stable cash flows that support the fixed dividend obligations.
Technology companies rarely issue preferred stock to the public, though they frequently issue preferred shares to venture capital investors in private financing rounds. Those preferred shares (with liquidation preferences, anti-dilution protections, and conversion rights) are structurally different from the publicly traded preferred stocks discussed here.
How Preferred Stock Trades
Most preferred stocks are listed on the NYSE or Nasdaq with a trading symbol that includes a letter suffix denoting the series. JPMorgan's Series DD preferred stock, for example, trades under the symbol JPM-PD (or JPM/PD, depending on the platform).
Preferred stocks trade at prices influenced by three primary factors:
Interest rates. Because preferred dividends are fixed, preferred stock prices have an inverse relationship with interest rates, similar to bonds. When rates rise, newly issued preferred stocks offer higher yields, making existing lower-yielding preferreds less attractive. Their prices decline. When rates fall, existing preferreds become more valuable and their prices rise.
The Federal Reserve's rate-hiking cycle from 2022 to 2024 caused significant declines in preferred stock prices. A preferred stock issued at $25 par with a 5% yield might have dropped to $20 or $21 as market yields rose above 6%.
Credit quality. A preferred stock from a financially stable company (JPMorgan, for example) trades at a lower yield than one from a company with weaker credit. If the issuer's financial condition deteriorates, the preferred stock price declines as investors demand a higher yield to compensate for the increased risk of a dividend suspension.
Call risk. When interest rates decline, callable preferred stocks face redemption risk. The company will likely call the preferred at par value, eliminating the investor's high-yielding position. This limits how far above par a callable preferred stock can trade.
Comparing Returns and Risk
Over long periods, common stock has produced higher total returns than preferred stock. The S&P 500 has returned roughly 10% per year historically (including dividends), while preferred stock indices have returned 5% to 7% per year with lower volatility.
The risk profiles differ fundamentally. Common stock risk is driven by business fundamentals: earnings growth, competitive position, and market sentiment. Preferred stock risk is driven primarily by interest rate movements and credit quality, with business fundamentals mattering only insofar as they affect the company's ability to pay the fixed dividend.
In a severe economic downturn, both common and preferred stocks decline. But preferred stocks decline less because their fixed dividend provides a floor (as long as the company can pay it). In a recovery, common stocks tend to rebound more sharply because they capture the full upside of improving earnings.
The worst-case scenario for preferred shareholders is a company that is distressed enough to suspend dividends but not quite bankrupt. The preferred investor receives no income, has no voting power to influence management, and holds a security with impaired value but no definitive resolution. At least in bankruptcy, the claims are sorted out through a legal process.
Tax Treatment
Preferred dividends from domestic corporations are generally classified as "qualified dividends" for tax purposes, taxed at the lower capital gains rates (0%, 15%, or 20%) rather than ordinary income rates. This is the same treatment common stock dividends receive.
Some preferred dividends are classified as interest rather than dividends, particularly for trust preferred securities (TruPS) and certain bank-issued preferred stocks with debt-like features. Interest income is taxed at ordinary income rates, which can be significantly higher.
REIT preferred dividends are typically non-qualified and taxed at ordinary income rates, consistent with the tax treatment of REIT common dividends.
The tax treatment should be verified for each specific preferred issue, as the classification depends on the legal structure of the security.
When Preferred Stock Makes Sense
Preferred stock fills a specific role for certain investors. Income-oriented investors who want higher yields than investment-grade bonds but less risk than common stocks find preferred stocks attractive. The typical preferred stock yields 5% to 7%, compared to 4% to 5% for investment-grade corporate bonds and 1% to 2% for S&P 500 dividend yield.
Investors in taxable accounts benefit from the qualified dividend tax treatment, which makes the after-tax yield of preferred stock more competitive with bonds than the pre-tax yield suggests.
Portfolio construction theory suggests that preferred stock can reduce overall portfolio volatility when substituted for a portion of common equity, since preferred prices are less sensitive to earnings fluctuations and more sensitive to interest rates, providing diversification of risk factors.
For investors seeking growth, capital appreciation, or inflation protection, common stock is the better instrument. Preferred stock's fixed dividend does not grow with inflation, and its limited price appreciation potential means it will lag common stock during bull markets. The investor who buys preferred stock is making a trade: accepting a ceiling on returns in exchange for priority of income and a lower-volatility experience.
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