Preferred stock has some perks, but not in bankruptcy

— -- Q: When a company goes bankrupt, do preferred shares have preference over common shares for payouts to shareholders?

A: Preferred stock is winning over investors who are afraid of stocks and afraid of bonds.

Preferred stock is bond-like because it comes with a regular stream of cash payments from the company. And, like bonds, dividends paid on preferred stock tend to be considerably higher than dividends paid on common shares.

Now, to answer your question directly: There's a bit of protection relative to common stock: Preferred stock has a higher claim on a company's assets than common shares when it comes to paying dividends. But, it's dangerous to think preferred stock will protect you if things go badly.

It is bondholders who are first in line for payouts if the company liquidates or goes into a major restructuring. I haven't seen data on recovery rates for preferred shareholders, but I suspect it's low.

Think of it this way. You're in line at a buffet on a cruise ship. There are about 100 hungry people in line and you're number 80. Clearly, that's better than being number 90 or 100. But the odds are pretty good that the 79 people in front of you will probably scoop most of the good stuff onto their plates by the time you get to it. That's probably what would happen with the assets of a company that runs into big trouble, even if you own preferred stock. Again, every case will be different.

There's another risk to remember: Preferred stock dividends can be suspended at any time. If a company runs into tough times, it can stop paying the preferred dividend just like it can common stock dividends. Companies don't have this kind of flexibility with bond payments. Bond payments must be paid, or the company is in default.

The biggest safeguard for preferred stockholders is that if a company suspends its preferred stock dividend, it must also stop paying dividends to common stockholders. And the company must keep track of the dividends it owes preferred stockholders. That unpaid amount must be repaid to preferred stockholders before the company can pay a dime to common shareholders.