Understanding What Preferred Shares Are

Have you ever heard of the term "preferred stock"? Yes, preferred stock is one type of stock traded on the stock exchange. In this case, a preferred stockholder has preferential rights compared to common stockholders. So, what is preferred stock? Is it really different from common stock?

In the stock market, there are two types of stocks traded: common stock and preferred stock. Now, to know more about what preferred stock is and its characteristics, let's take a look at the following explanation!

What Is Preferred Stock?

Preferred stock is a type of stock that grants priority or special rights to stockholders over the company's assets and profits. Preferred stock is a combination of bonds and common stock, providing a fixed income to its holders.

This is different from common stock, which can be traded in general. In common stock, stockholders receive dividends last, unlike preferred stock where its holders are prioritized in dividend distribution. Common stockholders do not receive the same privileges as preferred stockholders.

Characteristics of Preferred Stock

Preferred stock is certainly different from common stock. This can be seen from its different characteristics. Some characteristics of preferred stock that you need to know include:

  • Preferred stockholders have priority and are prioritized in dividend distribution.
  • They have different levels or classes.
  • They have the right to receive payment first for any deferred dividends by the company.
  • Under certain conditions, they can be converted into common stock.
  • They must be purchased in large nominal amounts.
  • They are generally not bought by individuals, but by companies or institutions.

Types of Preferred Stocks

To better understand preferred stocks, you need to know the following types:

1. Participating Preferred Stock

Participating preferred stock can provide additional dividends to shareholders based on decisions or resolutions made by the company. In this case, the company's decision is absolute.

2. Convertible Preferred Stock

Convertible preferred stock can be exchanged for common stock upon the request of the investor or based on the company's provisions. The conversion period is generally predetermined by both parties.

3. Adjustable Rate Preferred Stock

The next type is adjustable rate preferred stock, which has variable dividend values (can increase or decrease). The fluctuation of dividends depends on the reference interest rate, which can also fluctuate, or it can be influenced by currency exchange rates.

4. Callable Preferred Stock

Callable preferred stock can be redeemed by the company or issuer at a predetermined value before the maturity date. This type of stock combines debt and equity and is commonly used by companies for financing purposes.

5. Cumulative Preferred Stock

In this type of stock, the company is obligated to pay all dividends, including any accumulated arrears, to the shareholders. It encompasses the cumulative sum of all dividends.

Advantages of Preferred Stock

For shareholders, there are advantages to be gained from owning preferred stock, including:

  1. Priority in dividend distribution.
  2. Higher dividend amounts.
  3. Priority in capital during company liquidation.

Disadvantages of Preferred Stock

Despite having several advantages, preferred stockholders also face certain disadvantages, which include:

  1. Difficulty in trading due to large and expensive nominal values.
  2. Relatively small number of shares.

Calculating Preferred Stock

Once you understand what preferred stock is, you also need to know how to calculate it. To calculate preferred stock, you need information about the preferred stock price, the dividend rate of the preferred stock, and the risk-free interest rate.

Once you have this information, you can calculate the value of preferred stock using the following formula:

V = ────
(r – g)

V : value of preferred stock

D : dividend rate of preferred stock

r : risk-free interest rate

g : future dividend growth rate of preferred stock

With the above formula, you can determine the value of preferred stock independently. Generally, the future dividend growth rate of preferred stock is assumed to remain constant.

How to Buy Preferred Shares

It is important to note that investing in preferred shares is not as easy as buying common shares. The reason is that the number of preferred shares available in the market is very limited. You also need a significant amount of capital to purchase them. That is why typically this type of shares is only bought by specific companies or institutions.

It is very rare for individuals to buy preferred shares on the stock market. The majority of preferred shares are purchased by companies in large quantities. Companies issue preferred shares to obtain a significant amount of capital for their needs, hence the requirement for a large amount of capital to purchase them.

To buy preferred shares, you can do so through a securities company. However, the stock of this type of shares is very limited due to its restricted circulation. If you want to buy this type of shares or obtain more detailed purchasing information, you can directly inquire with the customer service of the relevant securities company.

That concludes a complete overview of asset management regarding what preferred shares are, their characteristics, and their advantages. Now you understand that this type of shares is different from common shares traded in general. That is why it is rare for individuals to own them.

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