Investing Guide

The Complete Guide to Preferred Stocks

Preferred stocks sit between bonds and common stocks in the capital structure. They pay fixed dividends, trade on exchanges, and offer yields that most fixed-income investors can only dream about. Here's everything you need to know.

6 Types

Explained

5 Metrics

You Must Know

6 Risks

To Manage

10 FAQs

Answered

What Are Preferred Stocks?

Preferred stocks are hybrid securities that combine features of both bonds and common stocks. They pay a fixed dividend (like a bond coupon), trade on stock exchanges (like common shares), and sit between bonds and common stock in the company's capital structure.

The “preferred” in preferred stock means these shareholders get paid before common shareholders. If a company pays dividends, preferred holders receive theirs first. If a company is liquidated, preferred holders are paid before common shareholders (but after bondholders).

Most preferred stocks have a par value of $25, pay quarterly dividends, and can be called (redeemed) by the issuer at par after a specified date. They typically don't have voting rights and have limited upside compared to common stock — but the income is more reliable and the yields are higher.

Think of preferred stocks as the fixed-income investor's equity — or the equity investor's bond. They're the middle ground, and for income-focused portfolios, they're one of the most powerful tools available.

Types of Preferred Stocks

Not all preferred stocks are created equal. The type determines your rights, risks, and potential returns.

Cumulative Preferred

If the issuer misses a dividend payment, the unpaid dividends accumulate and must be paid before any common stock dividends. This is the most investor-friendly type. If a company suspends dividends for three years, it owes you all three years of back payments before common shareholders see a dime.

Example: Fannie Mae preferred (FNMAS) — cumulative dividends suspended since 2008, now owed in full.

Non-Cumulative Preferred

Missed dividends are gone forever. The issuer has no obligation to make up skipped payments. Banks frequently issue non-cumulative preferred stock because regulators allow them to skip dividends during stress without creating a future liability.

Example: Most bank preferred shares (JPM, BAC, WFC series) are non-cumulative.

Convertible Preferred

Can be converted into a predetermined number of common shares at the holder's option or automatically upon certain triggers. This gives you the safety of preferred dividends plus potential upside if the common stock rises significantly.

Example: Tech companies sometimes issue convertible preferred to early investors.

Participating Preferred

Receives the stated dividend plus an additional dividend based on company performance. If the company earns above a threshold, participating preferred holders share in the upside alongside common shareholders. Rare in public markets but common in venture capital.

Example: Common in VC term sheets — investors get preferred dividends plus a share of remaining profits.

Perpetual Preferred

Has no maturity date — the issuer pays dividends indefinitely unless they call (redeem) the shares. Most preferred stocks traded on public exchanges are perpetual. The price trades based on interest rates, credit quality, and time to the optional call date.

Example: The vast majority of preferred stocks on the NYSE and Nasdaq are perpetual.

Fixed-to-Floating Preferred

Pays a fixed dividend rate for an initial period, then switches to a floating rate tied to a benchmark like SOFR or the 5-year Treasury. These became popular as issuers sought to limit long-term interest rate exposure while offering investors an initially attractive fixed rate.

Example: Many bank preferreds issued since 2015 use fixed-to-floating structures.

Key Metrics for Evaluating Preferred Stocks

These are the numbers that matter. Learn them and you'll understand 90% of preferred stock analysis.

Par Value (Liquidation Preference)

The face value of the preferred stock, typically $25 or $1,000 per share. This is the amount you receive if the company is liquidated or calls the shares. When preferred trades at $20 with a $25 par, you have a $5 discount to par — that's your margin of safety on the principal.

Usually $25 for retail-traded preferred, $1,000 for institutional.

Current Yield

The annual dividend divided by the current market price. This tells you what you're earning right now on your investment. If a $25 par preferred pays $1.75/year and trades at $22, your current yield is 7.95% — better than the stated coupon rate because you bought at a discount.

Annual Dividend / Current Price = Current Yield

Yield-to-Call (YTC)

The total return you'd earn if the issuer calls the shares at the first available call date. This includes both dividend income and the capital gain (or loss) from the difference between your purchase price and the call price. YTC is the single most important metric for callable preferreds trading above par.

Accounts for: dividends received + (call price - purchase price) / years to call

Credit Rating

Moody's, S&P, and Fitch rate preferred stocks based on the issuer's ability to pay dividends. Investment-grade (BBB- or higher) preferreds are safer but yield less. Below-investment-grade (BB+ or lower) preferreds yield more but carry meaningful default risk. Most preferred stocks are rated 1-3 notches below the issuer's senior debt.

Investment grade: BBB- or higher | Below investment grade: BB+ or lower

Stripped Yield

For preferreds with accumulated unpaid dividends, the stripped yield excludes the accumulated dividends from the price calculation. This gives you a cleaner picture of the ongoing income return. Critical for Fannie Mae and Freddie Mac preferreds where years of accumulated dividends are embedded in the price.

(Annual Dividend) / (Market Price - Accumulated Unpaid Dividends)

How to Evaluate a Preferred Stock

A step-by-step framework for analyzing any preferred stock before you buy.

Check the Credit Rating

Start with the issuer's credit rating from Moody's, S&P, or Fitch. Investment-grade (BBB- or higher) issuers are less likely to suspend dividends. Below-investment-grade issuers offer higher yields but carry real default risk. Know what you're buying.

Determine Cumulative vs. Non-Cumulative

This is the single most important structural feature. Cumulative preferreds protect you if dividends are suspended — the company owes you the back payments. Non-cumulative means missed payments are gone forever. Always prefer cumulative when possible.

Calculate Current Yield and Yield-to-Call

Current yield tells you what you're earning today. Yield-to-call tells you your total return if the shares are called. If the stock trades above par, YTC will be lower than current yield — and that's the number that matters.

Check the Call Date and Call Price

Know when the issuer can call the shares and at what price. Buying above par when the call date is near is a recipe for capital losses. Buying below par when the call date is far away gives you time to collect high-yield dividends.

Analyze the Issuer's Financials

Look at the issuer's debt-to-equity ratio, interest coverage, and recent earnings. A preferred stock is only as safe as the company behind it. If the issuer can't cover its fixed charges, your dividend is at risk.

Check Liquidity and Bid-Ask Spread

Verify average daily trading volume. Thin preferred stocks can have bid-ask spreads of $0.50-$1.00, which eats into your yield. If you can't get in and out cleanly, the advertised yield is an illusion.

Risks of Preferred Stock Investing

Preferred stocks are not risk-free. Understanding these risks is the difference between income investing and income praying.

High

Interest Rate Risk

Preferred stocks are long-duration fixed-income instruments. When interest rates rise, preferred stock prices fall — sometimes dramatically. A 2% rise in rates can send a perpetual preferred down 15-20%. This is the primary risk for most preferred stock investors.

Medium-High

Credit / Default Risk

If the issuer goes bankrupt, preferred shareholders are behind bondholders but ahead of common shareholders. In practice, preferred holders often recover pennies on the dollar in bankruptcy. Always check the credit rating and the issuer's financial health.

Medium

Call Risk

Issuers can call (redeem) preferred shares at par after the call date. If you bought at a premium to par, you lose money when the shares are called. This risk is highest when interest rates fall — issuers call expensive old preferreds and reissue cheaper ones.

Medium

Liquidity Risk

Many preferred stocks trade thinly — sometimes only a few thousand shares per day. Wide bid-ask spreads can eat into returns, and you may not be able to exit a large position quickly without moving the price. Always check the average daily volume before buying.

Medium

Dividend Suspension Risk

Companies can suspend preferred dividends, especially during financial distress. Non-cumulative preferreds lose those payments forever. Even cumulative preferreds can see dividends suspended for years — as Fannie Mae and Freddie Mac shareholders know firsthand since 2008.

Low-Medium

Inflation Risk

Fixed-rate preferreds pay the same nominal dividend forever. Over time, inflation erodes the purchasing power of that income. A 6% yield feels great at 2% inflation — but at 5% inflation, your real return is barely positive.

Rewards of Preferred Stock Investing

When the risks are managed, preferred stocks offer advantages that few other asset classes can match.

Higher Yields Than Bonds

Preferred stocks typically yield 1-3% more than bonds from the same issuer. The extra yield compensates for being lower in the capital structure, but for investors willing to accept that risk, the income advantage is real.

Priority Over Common Stock

In liquidation and for dividend payments, preferred shareholders are paid before common shareholders. This doesn't guarantee recovery in bankruptcy, but it provides meaningful protection in distressed situations.

Qualified Dividend Tax Treatment

Many preferred stock dividends qualify for the lower qualified dividend tax rate (0%, 15%, or 20%) rather than ordinary income rates. This after-tax advantage makes preferreds particularly attractive in taxable accounts compared to bonds.

Discount-to-Par Opportunities

When preferreds trade below par value, you get both income from dividends and potential capital appreciation if the price recovers to par. Buying below par creates a margin of safety — you're getting more yield and a potential capital gain.

Portfolio Diversification

Preferred stocks have different risk/return characteristics than both common stocks and bonds. They can reduce portfolio volatility while maintaining higher income than a pure bond allocation.

Personal Perspective

Glen's Approach to Preferred Stock Investing

I don't buy preferred stocks for 6% yields. I buy them when the market is mispricing the risk — when the discount to par value is so large that the math works even in pessimistic scenarios.

My concentrated position in Fannie Mae and Freddie Mac junior preferred stocks is the purest expression of this philosophy. These are cumulative preferred shares issued by two companies that guaranteed 70% of American mortgages, were placed into government conservatorship in 2008, and had their profits swept by the Net Worth Sweep in 2012.

The par value is $25. The accumulated unpaid dividends run into years of back payments. And the path to recapitalization — which would restore these shares to full value — has never been closer than it is right now.

Most preferred stock investors are buying income. I'm buying a mispriced option on justice. The preferred stock structure is what makes the thesis work — cumulative dividends, priority over common, and a par value that defines the upside.

Frequently Asked Questions

What is a preferred stock?

A preferred stock is a hybrid security that combines features of both stocks and bonds. Like bonds, preferred stocks pay a fixed dividend and have a par value. Like stocks, they trade on exchanges and can appreciate in price. Preferred shareholders receive dividends before common shareholders and have priority in liquidation, but typically don't have voting rights.

What is the difference between preferred stock and common stock?

Common stock gives you voting rights and unlimited upside potential but no guaranteed dividends. Preferred stock gives you a fixed dividend rate, priority in dividend payments and liquidation, but limited upside and typically no voting rights. Think of preferred stock as a more reliable income stream with less growth potential.

How are preferred stock dividends taxed?

Many preferred stock dividends qualify for the lower qualified dividend tax rate (0%, 15%, or 20% depending on your tax bracket) rather than ordinary income rates that apply to bond interest. However, preferred dividends from REITs and some financial institutions may be taxed as ordinary income. Always check the tax treatment before buying.

What does cumulative mean for preferred stock?

Cumulative means that if the company misses a preferred dividend payment, the unpaid dividends accumulate as an obligation. The company must pay all accumulated dividends to preferred shareholders before paying any dividends to common shareholders. This is a critical protection — Fannie Mae and Freddie Mac preferred shareholders are owed years of accumulated dividends under their cumulative terms.

What is par value for a preferred stock?

Par value (also called liquidation preference) is the face value of the preferred stock — typically $25 for retail-traded shares or $1,000 for institutional shares. It determines the dividend amount (a 6% coupon on $25 par pays $1.50/year) and is the price at which the issuer can call (redeem) the shares. Buying below par gives you a margin of safety.

Can you lose money on preferred stocks?

Yes. Preferred stock prices can decline due to rising interest rates, deteriorating credit quality, or market panic. If the issuer goes bankrupt, preferred shareholders may lose most or all of their investment. However, the risks can be managed through diversification, credit analysis, and buying at discounts to par value.

What is yield-to-call on a preferred stock?

Yield-to-call (YTC) calculates your total annualized return if the issuer redeems (calls) the preferred stock at the earliest call date. It accounts for both dividend income and the capital gain or loss from the difference between your purchase price and the call price ($25 par). YTC is the most important metric for callable preferreds trading above par.

Are preferred stocks a good investment in 2026?

Preferred stocks can be attractive in 2026 depending on your goals. With interest rates elevated, many preferreds trade at discounts to par value, offering both higher current yields and potential capital appreciation. However, if rates rise further, prices could decline. For income-focused investors willing to do credit analysis, the current environment offers opportunities — particularly in GSE preferred stocks where recapitalization could create significant upside.

What are the best preferred stocks to buy?

The best preferred stocks depend on your risk tolerance and investment thesis. For safety, look at investment-grade bank preferreds with strong credit ratings. For yield, look at below-investment-grade preferreds trading at deep discounts to par. For asymmetric upside, Glen Bradford focuses on Fannie Mae and Freddie Mac junior preferred stocks, where recapitalization could return shares to par value from current discounts.

How does Glen Bradford invest in preferred stocks?

Glen Bradford's approach centers on deep-value preferred stock investing with a concentrated focus on Fannie Mae and Freddie Mac junior preferred shares (tickers like FNMAS, FMCKJ). His thesis: these cumulative preferred stocks were unfairly deprived of dividends by the government's Net Worth Sweep, and recapitalization will restore their value to par ($25) plus years of accumulated unpaid dividends. He has held these positions since 2013.

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Disclaimer: This guide is for educational purposes only and does not constitute financial or investment advice. Glen Bradford holds positions in Fannie Mae and Freddie Mac preferred securities. Preferred stock investing involves risks including loss of principal. Past performance does not guarantee future results. Always do your own research. Some content was generated or edited with AI assistance.