Preferred stocks is a name given to a special category of stock which has characteristics differentiating it from the general or "common" stock of the same company. This can include advantages such as being first in line to get dividend payments or having priority over claims if the company goes into liquidation. There are some disadvantages, most notably that preferred stocks do not usually come with voting rights.
The precise characteristics of preferred stocks vary from company to company. The most common is that anyone holding preferred stocks will be higher up in the pecking order if a company is liquidated and its assets divided among creditors. Depending on the rules of the stock, holders of preferred stocks will either get back the amount they invested or the market value of their stocks when the company was liquidated. As long as there is enough money left in the company, these holders will get this amount back as a flat amount. Holders of ordinary stocks will have to wait in line with other creditors and will usually only get a portion of the money they are "owed."
Another characteristic of preferred stocks is that holders normally get paid a fixed dividend. This dividend is paid before the dividend payments to holders of ordinary stocks. The payments to ordinary stocks will be determined on a year by year basis and is usually dependent on the company's performance and cash reserves.
There is usually no guarantee that holders of preferred stocks will get a dividend payment. If they do, it must be paid at the agreed rate. This payment must be made before any dividend payment to other stockholders. The result of this is that it is impossible for a firm to make a dividend payment to ordinary stock holders without making one to preferred stock holders.
If a preferred stock is classed as cumulative, then whenever the company opts not to make a dividend payment, the amount it would have paid to preferred stock holders is carried over. For example, if the company makes no dividend payments whatsoever for two years, then in the third year it must pay preferred stock holders three years' worth of dividends before it is allowed to pay anything to holders of ordinary stocks. The alternative to this is known as non-cumulative. In this situation, if a company doesn't pay dividends one year, the holders of the preferred stock will never get any dividend for that year.
