While many individuals choose to invest in common stocks, some investors find value investing in preferred stocks. An attractive feature of preferred stocks for some investors is that the securities combine the benefits of investing in stocks and bonds.
Two common types of preferred stocks exist – perpetual and non-perpetual preferred stocks. Investors interested in preferred shares must understand the difference between perpetual and non-perpetual preferred stocks to determine the benefits of the investments to their investment portfolio.
Understanding Preferred Stock
Investors who purchase preferred stocks receive priority over common stockholders in the case of dividends and the liquidation of the company’s assets to pay investors. Common stockholders, on the other hand, have lower priority and may not end up getting any dividends in some cases.
For example, if a preferred stock is paying a $7 annual dividend, all preferred stockholders are guaranteed to receive the dividend before common stockholders. If in the future the company decides to raise the annual dividend to $10 because of positive revenue growth, the preferred stockholders will continue to receive a $7 annual dividend for their shares while common stockholders receive a $10 annual dividend.
Read More: Characteristics of a Preferred Stock
Perpetual Preferred Stock
A perpetual preferred stock pays a fixed dividend for an indefinite period; basically, for as along as the company remains in business. Holders of perpetual preferred stock will therefore receive dividends indefinitely – hence the word 'perpetual.' As such, it can look a lot like a bond with an extremely long maturity date.
Read More: How Is Preferred Stock Similar to Bonds?
Although a perpetual preferred stock does not have a specific buy-back date, it does have redemption features. Generally, the issuing corporation possesses the right to buy back the stock at any time under specific terms listed in the prospectus. Companies buy back shares for a variety of reasons, such as new tax laws and changes in interest rates.
For example, a company may choose to buy back your preferred shares if interest rates fall below the yield the company is paying to preferred shareholders.
Non-Perpetual Preferred Stock
Non-perpetual preferred shares carry characteristics of stocks and bonds. The shares trade like common stock but have a maturity date like bonds. A non-perpetual stock carries a specific maturity date when the company will buy back shares from preferred stockholders at a specified price. The dividends paid to investors cease when the company buys back the shares. In many cases, non-perpetual preferred stocks carry a maturity term of at least 30 years.
Why It Matters
Investors interested in preferred stock should understand the significance of the call feature associated with perpetual and non-perpetual shares. You may instantly lose a valuable income stream if the company chooses to suddenly buy back perpetual preferred shares.
If the buyback is a result of lower interest rates, you may find it difficult to find an investment paying a similar yield to the preferred shares that you lost.