Market Beat: What is a preferred stock?
March 25, 2012
TRUCKEE, Calif. andamp;#8212; When an investor buys stock in a corporation, he or she is buying an ownership stake in that company. Most investors buy common stock. Common stock grants voting rights to the shareholder and has more potential for capital appreciation.Preferred stock generally does not have voting rights but has a fixed dividend payment similar to a bond. The dividend payment on the preferred shares must be made before any dividends can be paid out to the common stockholders. Preferred stock can be perpetual, meaning that it can be held indefinitely or it can have a maturity date like a bond where the investor receives a set price known as par value for the stock at a set date.Some preferred stock is also convertible, meaning that it can be exchanged for a pre-determined number of shares of the common stock of the issuing corporation. If the preferred stock is cumulative, that means that if the company doesnandamp;#8217;t pay out the dividend, it will accumulate to be distributed at a future date.Preferred shares also have higher priority in liquidation than common stock. That means that the holders of preferred stock will get paid out before the common stock holders in the event of a bankruptcy. Some preferred shares are callable by the issuing corporation which means that the company has the right to buy the stock back at a pre-determined price at a set date.Most investors purchase preferred stock for income like a bond and purchase common stock for capital appreciation first and dividend income second. Preferred shares can pay some fairly attractive dividends in todayandamp;#8217;s low interest rate environment. For example there is an exchange traded fund that consists of nothing but preferred stocks. It has 239 different holdings from major corporations spread out across various sectors of the economy. The current yield on the preferred stock fund is 6.33%, which is a decent yield today relative to other alternatives.Preferred stock can produce some decent income and can be good for diversification in a portfolio. Like common stocks or bonds they also have risks. They are subject to interest rate risk which means that if interest rates rise, the value of the preferred stock can decline. They are also subject to credit risk. If the credit rating of the issuing corporation gets a downgrade the preferred shares can see a price decline as well.Kenneth Roberts is a Truckee based Registered Investment Advisor. Ken has been in the securities business since 1992, has worked as a branch manager for a major Wall Street firm, and is currently a portfolio manager for Fusion Asset Management. Information on his money management service can be found at http://www.fusiontargetretirement.com or by calling 775-657-8065. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.