The Disadvantages of Preferred Stock

When you hear the word "preferred," you probably think the item it refers to is better than a "common" version. That may, or may not, be the case when it comes to investing in stock. Preferred stock does get some preferential treatment over common stock issued by the same company, particularly when it comes to dividend payments. However, unlike bond interest, the dividends on preferred stock is not guaranteed.

No Voting Rights

Preferred stock gives the stockholder ownership in the company, similar to common stock. While a company's board of directors might choose to grant voting rights to its preferred stock, it's got no obligation to do so. Most preferred stock does not give the stockholder voting rights at the company's annual stockholders meeting.

Interest Rate Sensitive

Preferred stock is usually issued as a way for the company to raise capital without taking on new debt. It pays a fixed dividend in much the same way bonds pay a fixed rate of interest, so both are commonly thought of as fixed-income securities. Like bonds, preferred stocks are sensitive to fluctuations in prevailing interest rates. If prevailing rates increase, the market price of preferred stocks tend to fall. If prevailing rates decrease, the preferred stock prices tend to rise.

Call Provision

A company can include a call provision when it issues preferred stock. This allows the company to redeem the stock at a set price. If prevailing interest rates fall, the company can buy back its preferred stock and reissue new preferred stock at a lower dividend. It also limits your ability to score a capital gain. If interest rates fall, the market price of preferred stock should rise. However, the call provision can curb the enthusiasm since buyers know the company can redeem the preferred stock at a lower fixed price.

No Guarantees

Investors buy preferred stock because it usually pays a higher dividend than common stock issued by the same company. If the company gets liquidated, preferred stockholders get second crack at company assets, right after the bondholders. Preferred stockholders also get dividends before common stockholders, but that's no guarantee -- a troubled company may pay no dividends at all.

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