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Four Things You Need to Know About Preferred Stocks

by Melanie Peterson

The 2013 film “The Wolf of Wall Street” is often regarded as being one of the best starring Hollywood start Leonardo DiCaprio, but not many people know about the 2000 film “Boiler Room,” which presented the story of a young stockbroker working in a brokerage firm that was like a mirror image of Jordan Belfort’s Stratton Oakmont. One particular scene in “Boiler Room” revolves around a group job interview for prospective brokers, and the only one with a Series 7 license was quickly dismissed.

A Series 7 license is required of investment professionals who offer general equity securities, and they must pass an exam in which they must demonstrate knowledge on topics such as the various types of share classes. Coincidentally, there are seven types of share classes, but stockbrokers who work directly with retail clients mostly deal in a single class, which can be further split into common and preferred stock.

Most individual stock investors hold shares of common stock. Companies such as IBM only offer common stock; the same goes for other technology giants such as Apple and Microsoft, but nothing really stops them from offering preferred shares in the future if they wish to do so. Preferred stock is not offered as much as it used to be, but there are good reasons for investors to seek it. Here are four things you should know about preferred stock in 2021:

Preferred Stock Does Not Always Equal Preferential Status

If you want to establish strong voting rights and even have a say in the management of a company, do not look towards preferred stock because it does offer voting rights. You would be better off trying to accumulate enough common stock so that you become a majority shareholder. For this reason, some investment fund managers seek to accumulate both preferred and common shares.

Preferred Stock Offers Dividends

This is the most significant difference between preferred and common stock; whereas the former always pays dividends, the latter is in no obligation to do so. This does not mean that only preferred stock will pay out dividends because some companies do so through common shares as well. If you research a list of preferred stock opportunities to invest in, you will know that dividends will come your way at some point. With common shares, you will need to use a stock screener to filter this information. Smart investors will deposit these dividends into a compound interest account in order to get the most out of them through the magic of exponential reinvestment of profits.

Banks Are More Likely to Issue Preferred Stock

More than 85% of preferred stock currently trading on Wall Street these days is issued by banks. There are various reasons for this, and one of them is related to the way banks write their earnings and financial statements. Banks tend to be limited in the types of assets they can hold; preferred stock gives them an opportunity to list a separate kind of asset.

Preferred Stock Investors Come First

Should the company be forced into liquidation for any reason, the court will order that holders of preferred stock be paid first and before those who hold common shares. To this extent, preferred stocks work similar to bonds.

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