Preferred Stock Definition

• Preferred stock is a hybrid security that shares as much in common with bonds as with common stock. Preferred stock has a set dividend rate that companies advertise to investors (the rate can be based on several different metrics), which makes it much more reliable than normal stock. However, preferred stock does not often have the value fluctuation of common stock due to lower demand, and investors receive no ownership in the company by buying preferred stock.
  
  

Need for Cash

• Companies often sell preferred stock when they are in a sudden need of cash and cannot sell bonds or take out a loan as easily as create preferred stock. Sometimes companies create preferred stock that is convertible to normal stock when they are trying to entice new investors or slowly increase the amount of common stock outstanding. In small businesses not yet public, preferred stock may be the only way they have to raise money through equity.
  
  

Debt and Equity

• Some companies use preferred stock to control their debt/equity ratios. These ratios vary depending on industry and investor expectations, but companies usually have a certain range they need to stay in. Since preferred stock counts as equity, companies can use it to influence their ratios if they find they have too much debt.
  
  

Company Control

• Some businesses use preferred stock when they need extra equity, but cannot sell common stock because of company ownership problems. Shareholders who hold common stock hold company ownership. If the ownership becomes too diffused throughout many shareholders, the company becomes susceptible to a hostile takeover. Businesses concerned about this possibility use preferred stock at certain times to avoid ownership issues.
  
  

Considerations for Investors

• For investors, preferred stock is a double-edged sword. In some ways they are more reliable than common stock with their dependable dividends, but they will also not quickly rise in value in the same way common stock does. Also, while preferred stock is paid back first in case of bankruptcy, bonds and loans have even higher priority, so shareholders rarely receive money at all.