Definition of Preferred Stock

Preferred stock is equity shares that have preferred rights to receive the dividend before anything is distributed to ordinary shareholders. The dividend is paid out of earnings available after interest and taxes at a fixed percentage of preferred dividends. This means after settling all the payments related to debt holders (interest) and taxes the remainder is available first to the preference shareholders and after that, the ordinary shareholders are paid the residuals.

Preference shares or preferred stock is normally treated as equity because these are irredeemable until the company repurchases them or the company is liquidated. However, if there is a clause about the redemption of preferred stock they are treated as debt.