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What Is a Preferred Stock?
Preferred Stock Definition
There are two types of stocks: common and preferred stock.
Despite its name, preferred stock isn’t intrinsically superior to common stock.
Unlike common stock, preferred stock doesn’t come with the right to vote and has less potential to appreciate in price than common stock.
However, preferred stock comes with the right to receive dividends prior to common stockholders and have higher priority in getting paid back if the company goes bankrupt and is liquidated.
Preferred stock gets its name because preferred shareholders are in a “preferred” position to receive dividend payments and be paid back first in the event of bankruptcy.
Why the Term “Preferred”?
Although preferred stock is still equity, in many ways it is more like a hybrid between stock and a bond.
Preferred stock is like a bond because the income provided by preferred stock is more predictable than with common stock, is rated by major credit rating agencies, and is given higher priority than common stockholders.
It is like equity because, unlike a bond, failing to pay preferred shareholders dividends does not put a company in default, and the stock can appreciate in price.
The hybrid nature of preferred stock makes it a more attractive investment to certain investors.