Preferred stock and its features, convertible preferred included

Ownership with a preference

Preferred stock is equity, even when its income features resemble debt. Preferred shareholders rank ahead of common shareholders for dividends and their specified liquidation preference. Creditors, including bondholders, rank ahead of preferred shareholders. Priority does not assure recovery when assets are insufficient.

Stated dividends

Preferred stock usually has a stated dividend and limited or no ordinary voting rights. The dividend may be expressed in dollars per share or as a percentage of par. Six percent preferred with $100 par has a $6 stated annual dividend: $100 multiplied by 6%. The percentage applies to par, not market price. Dividends depend on declaration; they are not a lender's interest payments.

Features that change the rights

• Cumulative: unpaid stated dividends accumulate as dividends in arrears. Arrears and the current preferred dividend must be paid before a common dividend. Accumulation does not require immediate payment.
• Noncumulative: omitted dividends do not carry forward.
• Participating: the holder may receive additional distributions beyond the stated dividend under the issue's terms. Participation concerns extra distributions; accumulation concerns missed dividends.
• Callable: the issuer can redeem shares at a specified call price under specified conditions. Falling interest rates may encourage replacement with lower cost financing. A call creates reinvestment risk and can restrain price appreciation.
• Convertible: the holder can exchange preferred shares for common shares under the conversion terms. The conversion ratio specifies common shares per preferred share.

Conversion and price sensitivity

If one preferred share converts into four common shares and common trades at $20, conversion value is 4 multiplied by $20, or $80. Conversion value need not equal the preferred share's market price. Conversion offers exposure to common stock appreciation; the common shares received do not retain preferred dividend or liquidation priority.

Fixed dividend preferred generally moves inversely to market interest rates, other factors unchanged. Convertible preferred also responds to the common stock's price. Features can coexist: cumulative and callable describe different rights and may appear in the same issue.