Preferred Stock

Quick Definition

Preferred stock is a class of corporate equity that receives priority over common stock in dividend payments and asset claims during bankruptcy or liquidation, but typically carries no voting rights. It pays a fixed or adjustable dividend, similar to a bond's coupon, and trades on stock exchanges like common stock. Preferred stock sits between bonds (most senior) and common stock (least senior) in a company's capital structure.

What It Means

The word "preferred" reflects the priority treatment these shareholders receive. When a company distributes dividends, preferred stockholders are paid first. If the company is liquidated, preferred shareholders stand in line ahead of common stockholders to reclaim assets (though behind bondholders and other creditors).

In exchange for this priority, preferred shareholders typically sacrifice the voting rights that common stockholders have. They also give up unlimited upside. While common stock can theoretically increase without bound, preferred stock's price is largely anchored to its dividend yield, much like a bond's price moves with interest rates.

Preferred stock is most commonly issued by:

• Banks and financial institutions
• Utilities
• Real estate investment trusts (REITs)
• Companies in capital-intensive industries

The 2026 Preferred Securities Market

The preferred securities market entered 2026 with strong momentum. The ICE BofA Fixed Rate Preferred Index returned 5.13% in 2025, driven primarily by coupon income with a tailwind from falling rates (the 2-year Treasury yield dropped from 4.24% to approximately 3.47% over the year).

Morgan Stanley projects another year of positive returns in 2026, citing healthy corporate earnings, mid-cycle credit fundamentals, and anticipated Fed cuts. The ICE US Institutional Capital Securities Index spread stands at 185 basis points, essentially unchanged since mid-2024, suggesting preferreds continue to offer reasonable entry points even as other risk assets trade near historic valuation tights.

Cohen & Steers notes that preferreds currently offer some of the highest yields among investment-grade securities, ranging from 6 to 7%. Total return breakevens have risen to two to three times their late-2021 levels, providing a cushion against rising rates or widening credit spreads.

The retail $25-par market lagged institutional securities in 2025, with the ICE BofA Core Plus Fixed Rate Preferred Index rising only 3.6% as spreads drifted wider amid a steepening yield curve. However, relative value compared with the institutional market is now as favorable as it has been in three years.

REIT preferreds offer even higher yields. LDR Capital Management calculates an average yield of 8.2% for the sector, with 88% of US REIT preferreds trading at or below par value and approximately 25% upside to par. The asset class has a cumulative default rate of just 3.9% over the past 25 years (15 basis points per annum).

Types of Preferred Stock

Preferred Stock vs. Common Stock vs. Bonds

How Preferred Stock Dividends Work

Calculating Dividend Yield

Most preferred stock is issued with a par value (typically $25) and a stated dividend rate:

Annual Dividend = Par Value x Stated Rate Dividend Yield = Annual Dividend / Current Market Price

Example: A preferred share with $25 par value and 6% stated rate:

• Annual dividend: $25 x 6% = $1.50/year ($0.375/quarter)
• If trading at $25 (par): Yield = $1.50 / $25 = 6.0%
• If trading at $22 (discount): Yield = $1.50 / $22 = 6.82%
• If trading at $27 (premium): Yield = $1.50 / $27 = 5.56%

Cumulative Dividends: The Protection Feature

Scenario: A company with cumulative preferred stock skips dividend payments for two years during financial difficulty.

Non-cumulative preferred holders would receive nothing for years 1 and 2 and have no claim to make it up.

How Preferred Stock Price Behaves

Because preferred stock pays a fixed dividend, its price moves inversely with interest rates, just like bonds:

Example: You buy preferred stock at $25 par paying 6% ($1.50/year). Then market rates rise to 8%. New preferred shares are now issued at 8%. Your 6% shares must fall in price so their effective yield matches 8%:

• New price = $1.50 / 0.08 = $18.75
• You have lost $6.25 per share (25%) in price

This interest rate risk is the primary risk of holding preferred stock long-term.

Call Risk: The Hidden Danger

Most preferred stock is callable. The issuing company can redeem shares at par ($25) after a specified date (usually 5 years from issue). This creates call risk:

Scenario: You buy preferred stock at $27 (premium), paying 7% yield. Rates fall to 4%. The company calls the shares at $25.

• You paid: $27
• You receive: $25
• Capital loss: $2 per share (7.4%)
• Meanwhile, reinvesting at current 4% rates means your income falls

Callable preferred stock is generally not advantageous to hold at a significant premium to par for this reason. In December 2025, a major money-center bank priced a preferred security at a reset spread of 300 basis points, 43 basis points wider than comparable issuance in November 2024, reflecting this dynamic.

Who Buys Preferred Stock

Preferred stock is primarily purchased by:

1. Income investors seeking higher, more reliable yield than common stock dividends
2. Institutional investors including insurance companies, banks, and mutual funds
3. Corporate investors who receive a 50-70% dividend received deduction on preferred dividends, reducing their effective tax rate on this income
4. Retirees seeking fixed income with equity-like features

Preferred Stock in Practice: Real Examples

Major US companies with notable preferred stock programs:

Bank supply dynamics are shifting. US money-center banks returned to positive net supply in 2025 as regulatory clarity improved, but recent proposals regarding bank capital requirements could further reduce the need for new preferred stock, creating a scarcity premium for existing holders.

Risks of Preferred Stock

Preferred Stock ETFs

Most retail investors access preferred stock through ETFs:

These ETFs provide diversification across dozens or hundreds of preferred issues, eliminating the idiosyncratic risk of holding individual preferreds.

Key Points to Remember

• Preferred stock is a hybrid: equity by classification but bond-like in behavior (fixed dividend, interest rate sensitive)
• Preferred shareholders receive dividend priority over common stockholders but are behind all debt holders in bankruptcy
• Most preferred is non-voting; you have an economic claim but no voice in company governance
• Cumulative preferred protects your dividend rights even if payments are skipped; non-cumulative does not
• Preferred prices fall when interest rates rise; this is the primary ongoing risk
• Call risk means the issuer can buy back shares at par when rates fall, limiting upside and reinvestment options
• The ICE BofA Fixed Rate Preferred Index returned 5.13% in 2025, and yields range from 6 to 7% for institutional preferreds

Common Mistakes to Avoid

• Buying callable preferreds at a premium to par: If you pay $27 for a $25 par preferred and the company calls it at $25, you lose $2 per share. Always check the call date and call price before buying. If the shares trade above par, the call risk is real
• Ignoring credit quality of the issuer: Preferred dividends are not contractually required the way bond interest is. A company in distress will skip preferred dividends before defaulting on bonds. Check the issuer's credit rating and financial health before buying
• Assuming preferred dividends are guaranteed: Unlike bond interest, preferred dividends can be suspended at the board's discretion. Non-cumulative preferred holders lose those payments permanently. Cumulative preferred at least preserves the right to receive missed payments later
• Overlooking tax treatment: Some preferred dividends qualify for the lower long-term capital gains rate (0%, 15%, or 20%), while others are taxed as ordinary income. Check the issuer's documentation or your 1099-DIV before assuming the lower rate applies
• Concentrating in a single preferred issue: Individual preferreds carry company-specific risk. A preferred ETF spreads risk across hundreds of issues, which is safer for most retail investors

Frequently Asked Questions

Q: Are preferred stock dividends qualified for the lower dividend tax rate? A: Some are, some are not. Qualified preferred dividends are taxed at the lower long-term capital gains rate (0%, 15%, or 20% depending on income). Non-qualified preferred dividends are taxed as ordinary income. The tax treatment depends on the structure of the preferred and how long you have held it. Check the issuer's documentation or your 1099-DIV; qualified dividends are reported separately.

Q: Should I prefer preferred stock over bonds for income? A: Preferred stock typically offers higher yields than investment-grade corporate bonds to compensate for being junior in the capital structure and carrying more uncertainty. However, preferred dividends are not contractually required the way bond interest is. A company in distress will skip preferred dividends before defaulting on bonds. For safety, bonds rank higher. For yield, preferreds often win. For most income investors, a mix of both makes sense.

Q: What happens to preferred stock if a company goes bankrupt? A: Preferred stockholders have a claim on the company's assets ahead of common stockholders, but behind all creditors (bondholders, trade creditors, secured lenders). In most corporate bankruptcies, common and preferred stockholders receive little to nothing because creditors' claims consume the available assets. Preferred status matters mainly in partial recoveries or restructuring scenarios.

Q: Is convertible preferred stock better than regular preferred? A: It depends on your goals. Convertible preferred gives you the option to exchange your preferred shares for common stock at a predetermined price. This captures upside if the common stock rises significantly, while still protecting you with the preferred dividend and priority if things go poorly. The tradeoff is that convertible preferred typically offers a lower dividend yield than comparable non-convertible preferred.

Q: What is the difference between institutional and retail preferreds? A: Institutional preferreds typically have $1,000 par values and trade in larger blocks, while retail preferreds have $25 par values and trade on retail exchanges. In 2025, the retail $25-par market lagged institutional securities (3.6% vs. 5.13% return) as spreads drifted wider amid a steepening yield curve. Relative value between the two is now as favorable as it has been in three years, but retail preferreds remain more expensive on a spread basis.