Function

• One of the advantages of preferred stock is lower risk. In the event a company runs into trouble and is forced to liquidate, preferred stockholders are paid first after debts obligations are met. Preferred stock is also less volatile than common stock but still offers the chance of equity growth. Dividends are fixed and must be paid fist before common stock dividends.
  
  

Types

• Regular preferred shares are issued on a permanent basis like common stock shares. However, some preferred stock issues are callable (sometimes called redeemable preferred shares). After a specified date, the issuing company can buy back the shares at or above the market price. Another type is convertible preferred stock. On or after a specified date, investors may convert their preferred shares into common stock. Convertible preferred stock is advantageous if the company is on a strong growth track and common stock is expected to rise significantly in value.
  
  

Features

• Some preferred stocks have additional advantages. If a preferred stock is cumulative, any dividends that are not paid on time accrue and must be paid at a later date. Contingent preferred stock gains voting rights if the company fails to meet its dividend obligations, allowing investors the opportunity to push for changes in company operation or management. Participatory preferred stock can earn added dividends if the company's profits are good.
  
  

Purpose

• There are advantages of preferred stock for the issuing company. By selling preferred shares the company can improve its balance sheet with equity capital without diluting the voting power of existing common stock. The company is not legally obligated to pay dividends or to redeem the shares at a maturity date as is the case with bonds.
  
  

Considerations

• You should look carefully at any preferred stock to decide if its advantages make it a good investment. Although you will get fixed dividends higher than on most common stocks, they are considered regular income and taxed accordingly. For most investors preferred stock is an alternative to bonds as an income-generating security, so you should take prevailing rates on bonds into account in weighing the relative advantages of the two types of securities.