Introduction

Preferred shares, also known as preferred stocks, are issued by some companies in addition to ordinary shares. Ordinary shares are known as common shares / ordinary shares (or stocks). I would like to briefly introduce you to the most important characteristics and warn you of pitfalls, as the term preferred stock may lead some investors to be careless.

Why preferred shares?

Why does a company issue preferred shares at all? There are several reasons.

A company would like to issue bonds or take out a loan. However, the creditworthiness of the company is doubtful, and so this step is sometimes not possible. The issue of ordinary shares could also fail because the conditions are simply too unattractive for the buyers or the share price is so low that this would result in an enormously high dilution of the existing share mass (with correspondingly angry shareholders due to large share price losses).

With preferred shares, a company can issue a new “share class” with particularly advantageous conditions. For example, a higher dividend can be paid than for ordinary shares, and this also takes precedence over the dividend for ordinary shares when it is paid out. However, the company must now make this attractive to investors, and the interest rates can be very high. There are certainly preferred shares with annual interest rates of well over 10%, and depending on the share price performance, this can be 20, 30 or even 40% or more. You too will soon realize that there must be a catch with such high interest rates. Such interest rates are not only a heavy burden on the company, but it also shows that a company can obviously no longer obtain financing by other means.

If interest rates exceed 10% per annum, warning bells should ring and you should take a closer look at the “prospectus” with the conditions, in addition to the usual analysis of the company’s financial situation. If you get a bad feeling here (e.g. high debt ratio, losses over several years or similar), then leave it alone. And if you do take the plunge, you may be able to reap high returns in the short term, but the risk of default, i.e. inability to pay, is certainly very high.

If you are interested in preferred shares and want to analyze the company, the current credit ratings of companies can provide good information. Is the rating speculative or investment-grade, i.e. suitable for investment? You can also search (using Google or Yahoo Finance) to see whether the company has bonds in circulation. What are the current prices, are the bonds being offered well below par? That would be an alarm signal for a company that is already under severe financial stress. And again, this should ring alarm bells for you.

Details

So calculate the risk carefully. So if you buy a share that pays out around 20% a year and you are sure that the company is likely to survive the next few years, then it may be worthwhile.

preferred shares come before ordinary shares in the payout of residual values in the event of a company’s insolvency, but are otherwise still behind bonds, loans and other obligations of the company in the pecking order. They are said to be “junior” to other classes. It must therefore be clear that in the event of bankruptcy, preferred shares, like ordinary shareholders, will almost certainly be left completely empty-handed. In this case, the name gives the illusion of security.

More details

Preferred shares can be very complicated. The interest rate is often not fixed (except for the first few years), but fluctuating (floating). It can adapt to various underlyings (e.g. 1 percent above the Libor interest rate and similar constructs).

There are also different maturities, and such shares can be called back (callable) by a company if they fulfill a certain criterion (specific price, fixed date or other). Here, too, you should know the exact conditions, such as the redemption price or the earliest redemption date, in order to plan your investment correctly. Everyone has a different time horizon, so choose the one that suits you best.

There may also be the possibility that the shares are convertible, i.e. can be exchanged for ordinary shares.

Another disadvantage is the often low liquidity. By this we mean the turnover, the volume of shares traded. Even at a well-known company such as Goldman Sachs (see next section), for example, the preferred share series A (ticker: GS.PA, GS-A, GS.A or GS-PA, depending on the website there are unfortunately different nomenclatures of the same share), the dollar volume is below 100,000 on some days, while the ordinary share reaches a daily volume of well over US$ 100 million.
Such low volume in preferred stocks is not normally desirable for the investor, as it becomes much more difficult to buy or sell at the desired price. High volume is always an investor’s friend.

Preferred shares also do not carry any voting rights. So if you absolutely want to vote at the Annual General Meeting (mainly online via a form on the proxyvote.com platform), you should therefore buy ordinary shares rather than preferred shares.

As preferred shares are mainly bought as an income generator via the crisp dividends, they are naturally more in demand when interest rates are generally low. If interest rates are high, the attractiveness of the preferred share may fall considerably depending on the conditions, and thus of course also the value of the share.

Ordinary shares can also be traded outside normal stock exchange trading hours (premarket, after hours). However, this is not the case with preferred shares, and this should be borne in mind. In addition, there are no associated options for preferred shares.

Preferred stock is also treated somewhat differently for tax purposes. However, this is mainly relevant for US investors and not so much for international, foreign buyers like you.

Where can I find information on preferred shares?

As usual, you can find the normal information about a company, such as financials, etc., under Ordinary Shares. So if you search for Goldman Sachs shares (ticker: GS), there are plenty of pages with information about this bank. However, the exact details of the prepreferred ference share are often not so easy to find. Goldman Sachs, for example, also offers preferred shares in various series. This information can usually be found on the company’s “Investor Relations” page, but at Goldman Sachs it would be here. If you take the preferred share at the top of this page (Series A), you will notice that only 30,000 shares were issued on the issue date. That is very few, but the market value is US$ 25,000. Well, not many people can afford such a share, and that’s not a problem. Often you only buy a fraction, here it is 1/1000 of this value, i.e. nominally US$ 25. In May 2020, the real price was only around US$ 20, as bank shares are generally under pressure due to very low interest rates.

If you are looking for information on a company’s preferred stock, Google can help. Simply enter the company, the base ticker and “preferred stock” and you are sure to find what you are looking for. Otherwise, you can find a reasonably up-to-date overview of all US-listed preferred stocks here at dividendinvestor.com. The site is not completely up to date, but it does the job for an initial overview and further research.