INVESTING TERMS
What is
PREFERRED
Preferred stock is a type of stock that offers different rights to shareholders than common stock. Preferred stock holders receive regular
dividends and are repaid first
in the event of a bankruptcy
or merger. Companies
typically issue more common
shares than preferred ones,
which are generally prized by
investors looking for a steady income.
Deeper definition
At the most basic level, there are two kinds of stock: preferred and common. Preferred stock is rarer than common stock, generally comprising a small proportion of all shares. It’s often more expensive, and can come with a minimum purchase amount.
Preferred stock example
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STOCK?
The main difference is in
how investors extract value.
When a company pays a
dividend, it must issue
them to preferred stock
holders first before
paying anything to
common stock holders, who
sometimes don’t get paid a dividend at all. Holders of preferred shares are also repaid first in the event that the company has to liquidate its assets, such as in a merger or acquisition or a “solvency event” like bankruptcy.
SHORT-TERM
CAPITAL GAINS
Profits made from selling assets owned for one year or less.
LONG-TERM
CAPITAL GAINS
Profits made from selling assets owned for more than one year.
Jeff bought a vacation home for $100,000 and used it as a rental property for five years before selling it for $150,000, giving him a capital gain of $50,000.
Since he owned the property for more than one year, he calculated his long-term capital gain based on his tax bracket.
Since his annual income placed him in the 15 percent tax bracket ($37,651 to $91,150 for a single person in 2016), he didn’t have to pay any taxes on the profit.
If Susan pays only the minimum payment of $20 per month, it will take her 11 months to pay off her balance.
EBITDA doesn’t need to be measured by the Securities and Exchange Commission’s accounting standards, the Generally Accepted Accounting Principles (GAAP), so it is not a required line item on a company’s financial statement. EBITDA has become much more common in recent years, although many firms list an adjusted EBITDA figure.
Corporation X is a new startup looking for investors. It issues 10,000 shares, of which 1,000 are preferred shares. Investor Y purchases
200 preferred shares. She
can now sit tight while
dividends start rolling in,
netting herself a reliable
income as long as the
company is profitable.
Before the proliferation of
inexpensive computer
technology, it had been very
difficult to create and price
complicated derivative contracts, but this problem was more or less solved by the 1990s, thanks also to the Black-Scholes equation. Mortgage-backed securities became very common investment products. Instead of using derivatives to effectively balance risk, institutional traders began buying them up as ways to create leverage and take on much more risk. When the U.S. housing market began to crumble in 2006 and 2007, MBS investments spread throughout the banking system began to rapidly lose value, precipitating the crisis.
MARKET CAP
VALUE
OUTSTANDING SHARES
SHARE PRICE
OF THE STOCK
When a company issues more shares, the price of an individual share falls. Anti-dilutive preferred stock allows investors to receive more shares of a stock than he original paid for in the event that his are worth less as a result of a dilution.
The measure can be calculated by taking a company’s net income and adding back interest expense, taxes, depreciation, and amortization. Alternatively, it can be calculated by taking a company’s operating profit — EBIT, or earnings before interest and taxes — and adding depreciation and amortization.
Susan opens a credit card with a $1,000 credit limit and an interest rate of 14.99.
She makes a purchase of $200.
Susan understands she will pay interest on the balance until she pays it off, but she decides to carry a revolving balance.
If Susan pays only the minimum payment of $20 per month, it will take her 11 months to pay off her balance.
If shares of Dynaco rise
above $150, the buyer of
the options wins and
Englebert is obligated to
sell 100 shares to the
holder for $150. But if they
never hit the strike price of $150, Englebert wins and gets to keep the $200 premium the buyer paid. If shares of Dynaco get closer to the strike price of $150, the buyer can resell the option and make a profit off his speculative bet, but if shares of Dynaco decline — widening the spread between the strike price and the underlying asset price — the price of the option falls.
$100 million
$2
$20 million
$10 million
– Minus
PRICE PER SHARE
EXPENSES
Equals =
$30 million
NET PROFIT
>$10B
Stock represents a percentage of ownership in a company, the value of which is determined by the market and the volume of which is determined and issued by the company.
x
=
$10 Billion
PRICE/SHARE
MARKET CAP VALUE
NOT A LARGE CAP COMPANY
OUTSTANDING SHARES
PRICE/SHARE
MARKET CAP VALUE
A LARGE CAP COMPANY
=
63,000,000
$200
$12.6 Billion
Some preferred stocks have additional benefits, like:
Convertible preferred stock can be exchanged for common stock, but not vice versa.
Convertibility:
Anti-dilution:
However, unlike common stock, they don’t usually come with voting rights. In that sense, preferred stock is a way to entice early investors without jeopardizing the mission of the company’s owners.
The shareholder has the right to redeem her shares for a predetermined amount called a call price.
Callability:
![](https://media-s3-us-east-1.ceros.com/fidelity-interactive/images/2021/06/29/63ca7dbfc32b6ef6102f5c02bbcb58c5/shape-icon.svg)