Preferred shares have advantages, and drawbacks
— -- Q: How does a preferred shareholder benefit in comparison to a common shareholder when a firm achieves great financial success?
A: Preferred stock acts somewhat like stock and somewhat like a bond.
As with a bond, preferred shares generally pay a stream of cash from the issuing company. The payment's size is agreed ahead of time, and yields can be attractive. The payment remains the same, unless otherwise agreed upon, even if the company is doing well. But, unlike a bond, these cash payments to preferred stock holders are not legal obligations, and a company can stop paying if it hits tough times. The missed dividend payments are tallied up, though, and must be paid if the company gets back on its feet.
Many preferred shares come with a bonus for investors in the form of a conversion option. Convertible preferred shares, as they're called, let investors turn their preferred shares into common stock at a certain price. This is a way to let preferred investors participate in a company's financial success.
Let's say a company's stock is trading at $30, and you own convertible preferred shares that let you buy the stock for $40. If the stock languishes at $35 a share, you get the preferred dividend payment and that's it. But if the stock goes to $100 a share, you can turn your preferred shares into common shares for $40, essentially making $60 a share. Not bad.
Matt Krantz is a financial markets reporter at USA TODAY. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Click here to see previous Ask Matt columns.
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