Preferred stock is that which entitles its owner to profits or dividends in preference to other stockholders. "Guaranteed," "preferential," "preference" and like expressions mean the same. "Interest bearing" stock is a species of preferred stock similar to a bond, since the company has promised to pay interest in the nature of a fixed dividend upon such stock, in preference to the common stock. In case of preferred stock, its dividends are to be paid out of the profits of the company first, and the common stock is then entitled to what remains.

In the cases of certain trading and manufacturing concerns, instead of issuing bonds for borrowed capital, they issue preferred stock, in one or more classes, such as first preferred, second preferred and then common stock. Such stock usually has "cumulative" dividends, which means that a dividend passed at one period must be made up from future earnings before the unpreferred shares receive any portion of the profits.

Such preference stocks are almost the same as bonds, the difference being that they may or may not have preference of claim against the assets of the company in case of failure, depending upon the conditions under which they were issued, and the dividends are not absolutely due and payable, like the interest on a bond. In a year of depression or loss the dividend on preferred stock can be passed, and will cumulate, but in the case of bonds, if the interest is not paid foreclosure may result. Therefore preferred stock is better for the company than bonds, although the holder of the bond may feel more secure on account of the annual payments of interest being obligatory.

Since preferred stockholders have rights superior to common stockholders, in reference to dividends, it is essential that the creation of preferred stock should be strictly in accordance with the statutes of the state in which the company is organized. If the stock is divided into the two classes before being subscribed, every one subscribing to either class of stock assents to the conditions, but in case a company issues only common stock and afterwards finds itself short of capital to conduct the business, it may then issue preferred stock, as a means of raising funds. This can only be done, however, after a unanimous vote of all the holders of the common stock, properly certified to the Secretary of State and his permission received. The holders of the common stock thus agree to surrender the first earnings of the company to the preferred shareholders with the hope that by means of the additional capital and good management, there may be a profitable remainder left for them.

Many corporations reserve in the hands of the treasurer a quantity of stock to be sold or given away at some future time, as occasion or policy may require, for the promotion of the business. This is called treasury stock, and is the property of the corporation. In case the stock is given away or sold at a discount, however, should the company become insolvent, those holding such stock would be liable to the creditors of the company for the difference between the amount paid for the stock and its par value, and this notwithstanding the stock should bear the words "paid up stock" or "fully paid and non-assessable." Thus it will be seen that any person who accepts stock as a gift from a corporation for his "influence" or on account of his "standing" in the business community assumes a liability - not to the company if the stock is marked "paid up stock," but to the creditors in case the company fails.

Sometimes the stockholders of a corporation, after complete organization and during its business life, donate by mutual agreement a certain percentage of their stock to be held in the treasury of the corporation and sold, and the proceeds used in the corporate enterprise. This stock is also called "treasury stock." This plan is often adopted by stockholders of an insolvent corporation or of one whose assets are impaired, and the corporation is by that means made solvent. This plan is resorted to in many instances instead of an increase of capital stock. An increase of capital stock would not benefit the corporation unless the stock were donated to it, and under the circumstances could not be sold as readily as the treasury stock donated in the other method.

Watering stock consists in increasing the amount of stock issued beyond the value of the assets of the corporation. It is an art in which the present generation seems to have become expert, and by means of its clever manipulation great "operations" have been financed, to the enrichment of the manipulators. Suppose a gas company has a franchise to supply the city and public with gas, and charges what is believed to be a fair price therefor. After the company is well "a-going," by means of good management or through the invention of improved processes of manufacture it finds that it is making a very large profit and will be able to declare an exorbitant dividend. Knowing that if the public were aware of its large profits there would be an immediate clamor for a reduction in the price of gas, it sets about increasing its capital stock to two or three times the original amount and distributing it among the stockholders so that the rate of dividend will be reduced to the normal income on capital. Then again a corporation operating under a franchise for a town or city, like a street railway, may have a stipulation in its franchise that all net earnings over a certain percentage shall be paid into the municipal treasury, as a compensation for the use of the franchise. By watering its stock it manages to keep the percentage of earnings below the limit and thus avoids payment of the excess rightfully due to the municipality.