Do Preferred Stocks Fit in Your Portfolio?

A preferred stock offering gives a company an alternative to borrowing money from banks or other lending institutions. In most cases, a company may defer or cut dividends as well as go into arrears without much of a penalty or risk to their credit rating. If is for this reason many companies choose this route of financing versus issuing corporate debt.

Preferred stock is considered a hybrid investment since it has both the qualities of a stock as well as a bond. It is considered senior debt (higher ranking) to common stock, but are subordinate (lower ranking) to corporate bonds. In the case of a liquidation event, the shareholders will be first in line to get paid behind bond holders. They are rated by the major credit agencies such as Standard and Poor's and Moody's. If you are looking for higher yields than you'll find at your local bank and believe the economy and the stock market will continue to recover, this might be an investment looking into.

Benefits of preferred stock: Convertible into common stock: Stockholders may have the option of turning their shares into common stock depending on the stock issuance

Preference to dividends: Owners may receive special dividends that common shareholders will not.

Drawbacks: Nonvoting stock: You do not have voting rights

Callable at the option of the corporation. Your stock may be called in by the issuant.

Types:

Convertible Preferred Stock-These are issues that shareholders can exchange for a predetermined number of the company's common stock. This exchange can occur at any time the investor chooses. Once converted to common stock, it cannot be converted back.

Cumulative preferred stock-If the dividend is not paid, it will accumulate for future payment.

Exchangeable preferred stock-This type of stock carries the option to be exchanged for some other security upon certain conditions.

Monthly income preferred stock-This security is a combination of preferred stock and subordinated debt.

Participating Preferred Stock-These issues offer the holders the opportunity to receive extra dividends if the company achieves some predetermined financial goals. The investors who purchased this type of security receive their regular dividend regardless of how well or how poorly the company performs. This assumes the company does well enough to make the annual dividend payments. Additionally, investors may receive an extra dividend if the company hits predetermined sales/profitability goals.

Perpetual preferred stock-This type of security has no fixed date on which invested capital will be returned to the shareholder. The issuing corporation has a callable option. Most perpetual preferred stock is issued without a set redemption date; however it usually carries a higher premium.

Prior Preferred Stock-Many companies have different classes of preferred stock outstanding at the same time. One of these classes of stock is usually designated to be the one with the highest priority. If the company has only enough money to meet the dividend schedule on one of the preferred issues, it makes the dividend payments on the prior preferred. Therefore, issuances have less credit risk than the other preferred stocks but will usually offers a lower yield; this may be in the form of "Class A", "Class B" or Class C" shares etc.

Putable preferred stock-These issues have a "put" privilege whereby the holder may, upon certain circumstances, force the issuer to redeem shares.

Straight preferred stocks are issued and pay a set rate of interest to the holder. However, they are subject to be called by the corporation at anytime.

Like a bond, a straight preferred issuance does not participate in any future earnings or dividend growth of the company. Preferred shareholders do not participate in growth of the share price of the company's common stock.

Almost all preferred shares have a negotiated fixed dividend amount. The dividend is usually specified as a percentage of the par value or fixed amount. Sometimes dividends on preferred stock may be negotiated as floating and it may change according to a pre-determined base interest rate such as LIBOR.

Example: Suppose that an investor paid par ($100) today for a typical straight preferred stock. Such an investment would give a current yield of about 6%. Now suppose that in a few years 10-year Treasuries were to yield 13+% to maturity, as they did in the early 80s; one would expect preferred stock to yield at least 13%. This would knock their market price down to $46, for a 54% loss. (In all probability, they should yield 2% more than the Treasuries-or about 15%. Of course, this would reduce the market price down to about $40, resulting in a 60% loss.

There are a number of different types of preferred stocks and issuers available. If you are looking to spread your risk, there are ETFs (exchange traded funds) as well as mutual funds. Please see Yahoo Finance or   for a comprehensive list.

Please consult with a financial planner specializing in fixed income investments. if you are looking to investment alternatives, he/she should be able to present a number of options which include municipal bonds, cds as well as money market funds. 



Larry Lane is the editor for  , a social networking site dedicated to personal finance.

Larry Lane is the editor for   a social networking site dedicated to personal finance. Investorzoo will bring you weekly deals on credit cards, high yield checking accounts as well as CD and money market yields. You'll also find over a directory of over 10,000 financial professionals in many categories in all 50 states.

Are you a financial professional looking to help people with money issues and gain world wide exposure?   is the 1st true social network dedicated to the world of personal finance. Answer questions on our public forums, receive leads and start a profile. We are accepting profiles from any licensed professional (in good FINRA standing) or published financial author. If you have any questions, please drop me an email at  @  or 425-591-9315. The article above is intended to provide information of a general nature and may not be suitable for your individual situation. Please consult a qualified licensed financial advisor before making any financial decision. 

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