Market Beat: Preferred stocks for income
Preferred stocks can be a good way for income oriented investors to obtain cash flow in addition to bonds and dividend paying common stocks. Preferred shares currently pay a pretty good yield in this low interest rate environment that we’re in.
There are several preferred stocks and preferred stock mutual funds that have current yields over 5%, which is attractive when the 10-year U.S. Treasury bond is paying just over 1.7% and the long term 30-year U.S. Treasury bond has a yield of about 2.1%.
Preferred shareholders have a priority over common stock holders when it comes to the dividend. A company can reduce or suspend its common stock dividend at any time, but will have to pay preferred shareholders prior to paying a dividend to common stock holders. Preferred stock holders also do not having voting rights like common stock holders do. Some preferred stocks are convertible into shares of common stock, which give the investor some flexibility and the potential for capital appreciation as well as income.
It’s important to pay attention to the credit rating of a preferred stock, as they have credit ratings just like bonds and high yield preferred stocks can have a fairly high default rate especially in times of recession. Some preferred stocks have a set maturity date like bonds and there are others that are perpetual, they never mature and if the shareholder wants to sell, they must do so in the open market.
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Some pay a fixed rate of interest and some have an adjustable rate that can go up in a rising rate environment. Most of the adjustable rate issues have the interest rate attached to a benchmark like the LIBOR, plus an inflation adjuster.
Most preferred stocks have a par price of $25 per share, then will trade at either a premium or a discount to par based on their yield and the current interest rates. They can also have call provisions similar to bonds where the issuer can call them if it is to their advantage. If interest rates fall and they can re-issue more preferred shares at a lower rate, they will be highly likely to do so. In general, if you pay a premium for a preferred stock and it is callable, it will start approaching the par price in the year prior to the call date and will hold its value before then.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.
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