Why would preferred shares have less potential for capital gain compared to common stock?

Question

From the investopedia article on preferred vs. common shares:

Preferred shareholders have priority over common stockholders on earnings and assets in the event of liquidation and they have a fixed dividend (paid before common stockholders), but investors must weigh these positives against the negatives, including giving up their voting rights and less potential for appreciation

Why would preferred shares have less potential for appreciation? Is it because the dividend will be paid (possibly) only to preferred shareholders, but not to common shareholders, and hence the preferred share price will drop by the dividend amount on the ex-dividend date?

But in this case, the drop is compensated by the dividend itself, so obviously this explanation is not correct. What am I missing?

Answer 1

I once bought both preferred and common shares in a bankrupt company. It is true that those preferred shares had less potential for appreciation than the common shares. The reason is because the preferred shares were trading around $50 and had a face value of $1000. This means that if the bankruptcy proceedings ended up finding enough assets to make the preferred shares whole, then the preferred shareholders would be paid $1000 per share and no more than that. So if you bought the preferred shares at $50 and received $1000 per share for them, then you made a 1900% gain.

But if the bankruptcy proceedings found enough assets to pay not just the preferred shareholders but also the common shareholders, then the common shareholders had the potential for a greater gain than the preferred shareholders. The common stock was trading around 20 cents at the time, and if enough assets were found to pay $10 per share to the common shareholders, then that would have been a 4900% gain. The preferred shares were capped by their face value, but the common shares had no limit on how high they could go.

Answer 2

True blue preferred shares are considered loose hybrids of credit and equity. They are more senior than common equity in bankruptcy liquidation but pay out a dividend which is not mandatory.

Financial institutions issue the bulk of genuine preferred shares because of their need for more flexibility than a bond but not so much that they can afford the cost to shareholders by diluting common equity.

Since it is a credit-like security that receives none of the income from operations but merely pays out a potentially unpredictable yet fixed amount of income, it will perform much more like a bond, rising when interest rates fall and vice versa, and since interest rates do not move to the extent of common equity valuations, preferreds' price variances will correspond much more to bonds than common equities. If the company stops paying the preferred dividend or looks to become in financial trouble, the price of the preferred share should be expected to fall.

There are more modern preferred however. It has now become popular to fund intermediate startups with convertible preferred shares. Because these are derivatives based upon the common equity, they can be expected to be much more variant.

Answer 3

Why would preferred shares have less potential for capital gain compared to common stock?

Both of the answers you received provide factual information but they don't really answer your question.

Traditional preferred stocks are issued at $25 and they are callable at $25 in 5 years at the discretion of the company, though they have a perpetual maturity date.

The $25 call price acts as a cap. Why would anyone pay $30 or $35 or more for something potentially worth $25 in 5 years or less? If the company is healthy, preferred share price will fluctuate above and below $25 based on what interest rates are doing.