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Passive Income Investments | Preferred Stock

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Preferred stocks can a be a great tool to add more passive income to your portfolio. In this article we look at exactly what preferred stock is, why companies issue it, and some the advantages and risks for investors...

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David Garner
David Garner
Published On: September 5th, 2023

Preferred Stock | Passive Income Investments

Preferred stock is a unique investment instrument that occupies a middle ground between common stock and bonds.

It offers investors a distinct set of features and benefits that set it apart from traditional equity and debt securities.

In this article, we will delve into the world of preferred stock, exploring its characteristics, examples, reasons for issuance by companies, motivations for investors, as well as the potential advantages and risks associated with investing in preferred stocks.

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What is Preferred Stock?

Preferred stock, often simply referred to as “preferreds,” is a type of security that represents ownership in a company, much like common stock, yet comes with certain privileges that make it distinct.

Preferred stockholders have a higher claim on the company’s assets and earnings compared to common stockholders, but generally have limited voting rights.

Unlike common stock, preferred stockholders receive fixed dividends, which are typically paid out before any dividends are distributed to common stockholders.

Examples of Preferred Stocks and Dividend Yield

  1. The Coca-Cola Company (Ticker: KO):

    • Series: Series D Preferred Stock
    • Dividend Yield: Approximately 5.3%
    • This preferred stock offers investors a fixed dividend payout and is considered a reliable income source due to Coca-Cola’s stable financial performance.

  2. Bank of America Corporation (Ticker: BAC):

    • Series: Series KK Preferred Stock
    • Dividend Yield: Around 5.9%
    • Bank of America’s preferred stock provides investors with a relatively high dividend yield, attracting those seeking income from their investments.

  3. Verizon Communications Inc. (Ticker: VZ):

    • Series: Series A Preferred Stock
    • Dividend Yield: Roughly 5.2%
    • Verizon’s preferred stock is appealing to investors looking for both stable dividend income and the potential for capital appreciation.

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Why Companies Issue Preferred Stock

Companies choose to issue preferred stock for various reasons, each driven by their unique financial objectives.

One common reason is to raise capital without diluting existing common shareholders’ ownership or control.

Preferred stock can serve as a flexible financing option, allowing companies to secure funds for expansion, acquisitions, or other corporate initiatives.

Furthermore, the fixed dividend payments associated with preferred stock can be attractive to income-focused investors, making it a strategic way for companies to tap into this investor base.

Why Investors Buy Preferred Stock

Investors are drawn to preferred stock for several reasons, primarily centered around the potential for stable passive income and a certain degree of safety compared to common stock.

The fixed dividend payments offered by preferred stocks can provide a consistent passive income stream, which is particularly appealing in periods of economic uncertainty or low-interest rate environments.

Additionally, preferred stockholders have priority over common shareholders in case of bankruptcy, enhancing their potential to recover their investment.

As with any stock investment, there is also always the potential for capital appreciation if the company’s financial performance improves over time.

Benefits of Investing in Preferred Stock

  1. Stable Income: Preferred stockholders enjoy predictable and steady dividend payments, making them an attractive option for income-seeking investors.
  2. Priority in Distribution: In the event of company liquidation or bankruptcy, preferred stockholders are ahead of common stockholders in receiving their share of company assets.
  3. Potential for Capital Appreciation: While not as likely as with common stocks, preferred stocks can still appreciate in value over time, providing investors with the possibility of capital gains.
  4. Lower Volatility: Preferred stocks often exhibit lower price volatility compared to common stocks, offering a more stable investment option.

Risks of Investing in Preferred Stock

  1. Interest Rate Sensitivity: The value of preferred stocks can be influenced by changes in interest rates. When interest rates rise, the attractiveness of fixed dividend payments may diminish, affecting the market value of preferred stocks.
  2. Limited Capital Appreciation: Preferred stocks are generally less likely to experience significant capital appreciation compared to common stocks.
  3. Lack of Voting Power: Preferred stockholders usually have limited or no voting rights, which means they have minimal influence on corporate decisions.
  4. Call Risk: Companies often have the right to redeem (call back) their preferred stocks after a certain period. This can lead to the investor losing a potentially attractive investment if the company chooses to redeem the stock.

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Conclusion

In conclusion, preferred stock represents a hybrid investment that combines features of both equity and debt securities.

It appeals to investors seeking a reliable passive income stream, some degree of safety, and a potential for capital appreciation.

Companies issue preferred stock to raise capital while catering to passive income-focused investors.

While preferred stocks offer benefits such as stable passive income and priority in distribution, they also come with risks such as interest rate sensitivity and limited capital appreciation potential.

As with any investment, understanding the characteristics and risks of preferred stocks is essential for making informed decisions that align with one’s financial goals and risk tolerance.

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