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What is a Preferred Stock?

written by: Brian Nelson•edited by: Rebecca Scudder•updated: 3/17/2011

Warren Buffet has made headlines more than a few times in the last couple of years with his big investments in the preferred stock of some companies through his company Berkshire Hathaway. What is the definition of preferred stock and how can you make the same investments as Warren Buffet?

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    Preferred Stock: What Is It

    What is preferred stock is the first question many people ask when they hear about it whether it is in a news story or a stock tip. The definition for preferred stock is a stock which pays a set dividend rate which has preference in being paid before any dividends are paid to investors in common stock. This pay first concept is what gives preferred stock its name. However, most preferred stock carries no voting rights.

    In the event of a corporate liquidation, preferred stock holders are compensated before the owners of common stock. However, this has little practical value because preferred stock holders are behind all bond holders in such an event and it is rare that all bond holders are made whole in such a situation.

    Different types of preferred stock include:

    Cumulative Participating Preferred Stock

    --Preferred stock that accumulates any dividend that is not paid such that all back dividends must be paid before common stock dividends can be paid, and which participates in additional company profit via common dividend as well.

    Non-Cumulative Participating Preferred Stock

    --Similar to Cumulative Participating Preferred Stock except that if a dividend payment is missed, it is simply lost and will not be made up.

    Non-Participating Preferred Stock is only paid the stated dividend regardless of company profits and payment of higher dividends to other stockholders.

    Convertible Preferred Stock

    --In addition to being paid the stipulated preferred dividend, the stock may be converted into a certain number of common stock shares.

    Adjustable-Rate Preferred Stock

    --While the dividend rate still holds preferred payment status, the amount of the payment varies depending upon current interest rates.

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    Best Preferred Stocks Investment

    While no one investment is best for everyone, some preferred stocks are more highly valued by certain investors. Until recently, high-yield bank preferred stock was frequently sought after. However, during the banking crisis many institutions were forced to suspend the dividends on their preferred stock. For example, U.S. government regulators instructed Fannie Mae and Freddie Mac to suspend payment of preferred stock dividends.

    For investors looking to invest in preferred stocks without having to choose individual stock issues, there are exchange traded funds and mutual funds that invest in preferred stock. For example, the iShares S&P U.S. Preferred Stock Index fund was the fourth most popular exchange traded fund in 2010.

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    Preferred Stock List and Their Yields

    Here is a list of some preferred stocks and their yields that Warren Buffet bought during the last several years.

    General Electric Preferred StockGE Preferred Stock Yield is 10% for Warren Buffet’s Investment (no GE preferred stock is available to the public.)

    Goldman Sachs Preferred Stock Coupon Yield Is 10% For Warren Buffet’s investment.

    Note that Warren Buffet’s investment in Harley Davidson was actually in a bond offering and not in preferred stock.

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    Downs, John. Dictionary of Finance Terms and Investment. Barron's Educational Series, 2010.

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