Preferred Stock

Whoever buys a share buys a small stake in a company. Normally, two things come with this: a claim to a portion of the profit and a vote on important decisions. These decisions are made at the shareholders' meeting, the annual gathering of all shareholders. Preferred stock separates these two things from one another. Its holders usually forgo the vote, but in return receive a larger or more reliable share of the profit. The payout of profit to shareholders is called a dividend.

Why companies have shareholders give up their votes

A company that wants to grow needs money. It can borrow money, or it can issue and sell new shares. The second path has a catch: whoever issues new shares also redistributes power. A founding family that previously held the majority can suddenly find itself outvoted after the issuance.

Preferred stock solves exactly this problem. The company raises fresh money without giving up control. As compensation for the missing voting right, buyers receive a financial advantage. In Germany, this is required by law: without voting rights, there must be a preference in the dividend. Otherwise, the share would simply be worse than a normal one.

For investors, this results in a simple calculation. Whoever owns only a few shares has hardly any influence at the shareholders' meeting anyway. A single vote among millions changes nothing. For such investors, the higher dividend is more attractive than a voting right they could never meaningfully use. Large investors, on the other hand, are happy to pay more for voting rights.

What the preference concretely means

The most common preference is a premium on the dividend. If a company pays, for example, two euros on the common share, the preferred share might receive 2.06 euros. The difference seems small, but it applies year after year. At some companies, the preference is a fixed amount; at others, it is a percentage surcharge.

Often more important is the second rule: the catch-up effect. If a company cannot pay a dividend in a bad year, the claim of preferred shareholders remains in place. In the next good year, this backlog is settled first, and only afterward do common shareholders receive anything. This is referred to as cumulative preferred stock. If the payment is missed for two years in a row, voting rights are even reinstated in Germany.

A common misconception: preferred stock is safer than common stock. This is only partly true. If the company goes bankrupt, both types of shares stand at the very back of the line of creditors. Whoever lent the company money is paid first. The preference applies to profit distribution, not to insolvency.

Preferred and common shares on the stock exchange

In Germany, preferred stock is especially common among traditional family businesses. Well-known examples are Volkswagen, Henkel, Porsche, and Sartorius. At some of these companies, both types of shares are traded separately on the stock exchange. The ticker often contains a “Vz” for preferred stock and an “St” for common stock.

The price difference between the two is interesting. Usually, preferred shares are somewhat cheaper because the voting right is missing. This gap is called the spread. It can change significantly when a takeover attempt is on the horizon. Then voting rights suddenly become valuable, and common shares rise much more strongly.

In stock market news, the term therefore frequently appears in reports about power struggles within corporations. Related structures are also encountered at young technology companies, usually there under the English name Preferred Shares. Whoever wants to buy a share should in any case look closely at which variant is meant. Price figures in tables do not always refer to the same type of share.