Preferred stock, also known as non-participating preferred stock, is a type of stock that pays the investor a specific dividend only. Generally, preferred stockholders do not receive any extra dividends that are paid to common stockholders. When a provision is added allowing preferred stockholders to share in additional dividends, the stock is known as participating preferred stock.
Participating preferred stock dividends are usually a fixed percentage of the par value of the stock. Sometimes, an adjustable rate provision exists with a certain stock. In this case, the payout is usually based on the movement of benchmarks, such as U.S. Treasury interest rates.
Participating preferred stock owners usually do not have any voting rights at stockholder meetings. Owners of common stock do have voting rights. A provision is sometimes added to allow preferred stockholders to have voting rights for a specific period of time. This usually happens when dividends are not paid.
Typically, participating preferred stock dividends are paid only when the company is doing well and making a profit. If the company is not doing well, dividends may or may not be owed to the investor. Cumulative participating preferred stock can accrue dividends that will be paid to the investor once the company’s performance improves.
Investors who own non-cumulative participating stock are paid dividends only when the company performs well. Dividends that are not accrued will not be paid at a later date. When the company performance improves, dividends will be paid for the current period only.
Whether preferred stock is participating, cumulative, or includes voting rights, is usually outlined in the stock’s prospectus. A prospectus is a document provided by the stock issuer that outlines all the details of a particular preferred stock investment. Investors can read the prospectus carefully prior to purchasing the preferred stock.
The prospectus will also indicate whether the preferred stock is convertible. Convertible preferred stock holders have the right to convert their preferred shares to common shares. In addition, the prospectus will tell the investor whether the company has the right to redeem the stock. If such a provision is included, the issuer can buy back the stock from the investor at any time, whether or not the investor wants to sell it.
In the United States, due to the to tax treatment of participating preferred stock dividends, corporations are the major buyers of this type of stock. Usually, corporations pay less tax on preferred stocks than they pay on bond interest. Generally, the reverse is true for the individual investor. As a result, participating preferred stock is not a very popular choice with small investors.