Is preferred stock an asset? This question has been asked severally by investors who are considering if investing in preferred stock will prove beneficial and add to the growth of their stock portfolio as well as their income. Preferred stock is a type of stock issued by companies that can be bought by investors on the stock market just like common stocks. Other kinds of stocks include dividends, large-cap, equity, mid-cap, penny, growth, income, small-cap, value, fractional, etc. Our discussion here shall focus on answering the question of whether the preferred stock is an asset but first, let us understand some basics about preferred stocks.
What is preferred stock?
Preferred stock is a security that represents ownership in the company that issues it. It is a hybrid that combines the characteristics of bonds and common stock. When it comes to a claim on the issuing company’s assets, they have a lesser claim relative to bonds and a higher claim relative to common stocks. Preferred stock is also known as preferred, preference shares, or preferred shares.
Preferred and common stock are the two major stock types that companies issue as a means of raising capital to finance various purchases, growth, and developmental projects of the issuing company such as the purchase of machinery, equipment, furniture, and plant. Expansion to new regions or expanding the company’s size in already existing locations. Research and development of new products or services.
Preferred stocks act like bonds in the fixed dividends that their owners earn and act like common stocks in the possibility of their price appreciating over time. Thus, these stocks are said to be hybrid instrument security. The dividend payments received are either paid quarterly, semi-annually, or annually depending on the terms in the stock prospectus. These stocks are normally a small portion of all the shares issued by a company, this is because it is more expansive than common stocks which are the majority of stocks issued by most companies.
Characteristics of preferred stock
The characteristics of preferred stock are those attributes that differentiate them from other types of stocks. We shall look at these characteristics below:
- The most prominent characteristic of preferred stock is that it is a mixed security instrument that has features of both bonds and common stocks.
- Preferred stocks enable their holders to have a claim on the issuing company’s assets upon liquidation of the company. This claim to assets is inferior to that of bondholders and superior to that of common stockholders.
- Holders of preferred stock are entitled to partake in the company’s profits through the dividend payments that they get. The dividends could be a fixed rate which could be a percentage of the stock’s par value or a specified dollar amount. It could also be a floating rate based on the interest rate of a benchmark such as the London Interbank Offered Rate (LIBOR)
- Preferred stockholders are shown preference when dividends are paid. This means that they get paid first before other stockholders of the company. If a company that pays its stockholders dividends is unable to pay them due to financial struggles or reinvestments, holders of preferred stock still get paid first once dividend payments resume and in some instances, they may also get paid the arrears dividends too.
- Generally, preferred stocks are nonvoting. This means that their holders cannot vote in on matters in the issuing company. There are however instances when the holders of these shares might be allowed to vote, if this happens, it is considered an extraordinary event.
- Preferred stocks could be converted to a prefixed number of common stocks at or after a predetermined date or at the approval of the issuing company’s board of directors.
- Preferred stocks can be bought back by the issuing company. If this happens, the shares that are bought back are known as treasury stocks. If a preferred stock can be bought back by the issuer, it is usually at or after a specified date which is often indicated in the stock prospectus and the stockholder gets paid back the stock’s par value.
What is an asset?
Any resource that an individual or corporate organization owns that can provide future economic benefits is considered an asset. The economic benefit can be an increase in cash inflow or a decrease in cash outflow that can be attributed to that particular resource.
Assets represent value that can be converted to cash or that can be used to obtain a positive economic value. Corporate organizations classify their assets into current assets and long-term assets. The current assets are those which can be converted into cash within a fiscal year. Long-term assets are those that require more than one fiscal year to be converted to cash.
Assets generally appreciate in value over time and can be either tangible or intangible. Tangible assets are resources that can be physically seen, they include land, buildings, plants, machinery, cash, etc. Intangible assets are non-physical resources such as goodwill, patents, intellectual property, trademarks, computer programs, copyrights, etc.
Is preferred stock an asset?
When a company prepares its balance sheet, preferred stock is recorded as equity rather than an asset alongside common stock and retained earnings. However, for holders of preferred stock, it is considered an asset because it increases their cash inflow through the fixed and regular dividend payments they get for owning these stocks.
As mentioned earlier, preferred and common stock is both parts of the equity in the issuing company’s balance sheet. The balance sheet of a company is a financial record that shows its financial standing and liquidity that comprises three main parts viz assets, liabilities, and equity.
The assets section comprises the current and long-term assets such as accounts receivable, buildings, cash, machinery, goodwill, copyright, etc. The liabilities section comprises short and long-term liabilities which include accounts payable, employee wages, cost of utilities, mortgages, etc. The equity section is where income from the sale of preferred stock and common stock is recorded alongside the company’s retained earnings. Therefore, preferred stock in itself is not an asset to the issuing company although the cash gotten from their sale could be an asset since it can be used to derive future economic benefits to the company.
Investors who own preferred stock do consider it an asset. Based on our earlier definition of an asset as any resource that provides economic benefits to the owner, we can see why investors will say the preferred stock is an asset. The fixed and regular dividend payments they are entitled to receive either quarterly, semi-annually, or annually are definitely a positive economic benefit.
Furthermore, having a higher claim at dividend payments and in cases of the issuing company’s liquidation is another major advantage of owning preferred stock. Hence investors can leverage the various beneficial characteristics of preferred stocks to add to their assets base.
Blessing's experience lies in business, finance, literature, and marketing. She enjoys writing or editing in these fields, reflecting her experiences and expertise in all the content that she writes.