When companies issue stock, they typically offer both common and preferred shares. Preferred stock differs from common stock in that it takes priority, which means that a company must pay dividends to preferred stockholders before making payments to holders of common stock. Additionally, preferred stock dividends generally yield more than those of common stock. Preferred stock holders also get to claim assets from a company's liquidation before common stock holders but after debt holders. Often, preferred stock does not come with the same voting rights that all common stock confers.
Companies that issue preferred stock can offer investors redeemable and retractable shares.
Redeemable preferred stock
Redeemable preferred stock is a type of preferred stock that includes a provision allowing the issuer to buy it back at a specific price and retire it. Also known as callable preferred stock, redeemable preferred stock can be advantageous for issuers because it gives them more financial flexibility. If a company issues redeemable preferred stock with an 8% dividend rate and determines in the future that it can instead issue new shares with a 4% dividend rate, it can simply call or redeem its more expensive shares. To do so, the company must send its stockholders a redemption notice informing them that their shares are being redeemed. The company must also abide by the call price and premium (the dollar amount that exceeds the par value of the shares) as detailed in its offering prospectus.
Retractable preferred stock
Sometimes preferred stock is issued without a maturity date, in which case the shares are considered perpetual. In other cases, preferred shares are issued with a maturity date, at which point the issuing company is allowed to force stockholders to redeem its shares in exchange for a predetermined payment. These shares are known retractable. In some situations, retractable preferred shares are subject to a "soft" retraction, which means that the issuing company has the right to exchange them for shares of common stock instead of cash. As is the case with redeemable shares, the terms of retractable shares must be spelled out in the issuer's prospectus. Companies that expect to have extra cash on hand at a certain point in time might opt to issue retractable preferred shares. This way, they can access the capital they need up front with the knowledge that once the shares mature, their stockholders will cash them in and they will no longer be liable for dividend payments.
Benefits and drawbacks for investors
Redeemable shares can be unfavorable to investors if the call price of the shares is lower than that of the current market price of a company's preferred shares. Furthermore, investors whose shares are called then face the challenge of reinvesting their money for a comparable return, which may not be possible at the time of the call date. On the plus side, redeemable shares generally have a built-in call premium to compensate investors for taking on added reinvestment risk.
Retractable shares can be beneficial for investors because their value tends to remain steadily at or above par, or face value. Traditional preferred shares, by contrast, tend to fluctuate more, and investors can lose money if share prices fall.
Feel like you're ready to take the plunge into investing? Head over to The Motley Fool's Broker Center and get started today.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at email@example.com. Thanks -- and Fool on!