What is convertible stock?
When you own preferred stocks, you could have the option of converting some of them into common stocks. Convertible preferred stock can be defined as a type preferred stock that has an option to convert them into a fixed number of common stocks after a waiting period.
Investors know the total number of common stocks they will receive for the conversion when the conversion takes place. This means that you will not be able to know this information ahead of time because the conversion rate of your preferred stock will depend on the performance of the common stock.
Basics on types of stocks
All types of stocks give you ownership in a company. There are two main types of stocks. The first is a common stock which is more common and gives you more benefits in the long term. With common stock, you get to vote on the corporate policies and elect the board of directors. However, you receive a lower rank on assets during the liquidation of the company.
The second type of stock is preferred stock. This type of stock gives you more rights on assets if the company you own is liquidated and you receive quarterly dividends. However, preferred stockholders cannot elect shareholders or vote on corporate policies.
According to UpCounsel, preferred stocks can be divided into subgroups which are the following.
- Callable preferred
- Cumulative preferred
- Convertible preferred
- Participating preferred
Convertible preferred stocks will give their holders an option to convert them into common stock.
Benefits of convertible preferred stock
By owning preferred stock, you are entitled to a fixed rate of dividends which is a huge benefit over common stock.
You can also have an option to convert your shares into common stocks. For example, when companies become more profitable, they sometimes increase dividends paid to common stockholders.
In case common stock dividends can become more than your preferred stock dividends. You can convert them into common stock to take advantage of higher dividends.
Convertible preferred stock gives you an advantage over common stocks when the company goes bankrupt. Common stockholders will receive their shares on assets after you are paid.
Disadvantages of convertible preferred stocks
Once you convert your shares into common shares, they will be treated as common stock. That means you will lose the fixed amount of dividends you once received before the conversion.
You will also drop in a hierarchical order for the rights of assets during the liquidation of the company. Before the conversion, you would receive rights on assets before common stock. Now you will be at the bottom of the ladder as common stockholders during the liquidation.
