Investing in Preferred Stock

Homepreneurs wants to help the reader make money. Sometimes we suggest simple jobs like being an election judge and sometimes we post an article about investments. Today’s post is about investing in preferred stocks and ETFs.

Preferred stocks are a hybrid class of ownership in some corporations that has characteristics of both stocks and bonds. Preferred issues have a priority claim over common stock on assets and dividends, but are second to bondholders. In general, preferred stockholders must be paid dividends before common stock holders receive payouts.

Preferred stocks typically pay a fixed dividend over a set period of time, though some companies may have adjustable rates. Preferred stocks can sometimes be perpetual and pay dividends for very long times. Preferred stocks carry no voting rights, unlike common stockholders. A number of preferred issues are “cumulative” – even if dividends are suspended, companies must pay all accumulated dividends when payments are resumed. This is not true for common stocks.

Preferred stocks are typically less volatile than common stocks and the prices don’t fluctuate as much. Preferred stocks often are less liquid than common stocks and daily trading volume is minimal. Often issued at $25 per share, preferred stocks usually trade within a narrow range from the issued price. Preferred stocks, when called due (maturity date), pay the holder back the original $25 per share investment. If a preferred issue is purchased for more than $25 a share, the owner will still receive only $25 per share. In contrast, if a preferred holder buys at under the issue price, money is made when the preferred issue is called.

Some preferred stocks are convertible – when called, the holder of the preferred stock receives common stock in the issuing company instead of money. This may or not be favorable and depends on the underlying strength of the company.

Preferred stocks often have a yield that is higher than common stock issued by the same company. This is typically because preferred holders have no voting rights on company business and because preferred stock doesn’t appreciate (capital gains) unlike common stock. The higher yield offsets the downside of owning preferred.

All companies do not issue preferred stocks. Typically, companies in industries like real estate (REITs), banking, utilities, and energy are issuers of preferred.

A list of companies with preferred stocks: Preferred Stocks

preferred stock

Why I own Preferred Stocks

My goal as an investor is to build a monthly dividend stream for the future. Since preferred stocks pay solid and predictable dividends, I own some individual preferreds and also a couple preferred ETFs, or exchange traded funds. The yield from these holdings varies from 6% (PGX) to 9% (SSW-H). The amounts sure beat savings accounts and money-market funds. I know that I will receive a specific amount every month or quarter from my holdings. While I am still in the accumulating phase, I know I can re-invest the dividends into the same fund or take the cash and buy another issue. For instance, I own 102 share of PGX, Powershares Preferred Portfolio. It holds primarily banks and other financial institutions. The effective yield is 5.6%, roughly, and on the 30th of every month I receive roughly $7.70 (and growing). I automatically reinvest the dividend amount and buy more PGX. Next month, I will have roughly 102.5 shares of PGX. In the short-term, the amount is not significant. In the long term, reinvesting those dividends will be huge. In two years, I will have 115 shares of PGX that pays a monthly dividend of roughly $8.70.

(For the above example, I used a fixed price of $15.00 as a share price for PGX. The price will vary each month, but can’t be determined).

Imagine how much that will pay off in 10 or 20 or 30 years? That is the beauty of compounding interest and re-invested dividends.

Risks to Preferred Stocks

As with any investment, preferred stocks have risks, too. One major risk is interest rates. If interest rates go much higher, individual preferred stocks will stay at the original yield and one may fall behind. Good for the issuing company, bad for the investor.

External factors. Preferred stocks price and yield can be affected by recessions, issuing company problems or other macroeconomic issues. While safer than common stock, some risk does exist. Since many ETFs hold financial institutions, macroeconomic factors can really hurt. During the Great Recession, virtually all investments were hurt and this includes preferred stocks.

A Final Thought

Some investors use only preferred stocks in their portfolio. Norman Roberts at Seeking Alpha (dot com) is an ardent individual preferred investor, eschewing common stocks altogether.

While I, as an amateur investor do not stick exclusively with preferred issues, PGX is my biggest and a core holding. I believe any income-oriented investor should have some preferred stock (or ETF) in their portfolio. For retirees that need income, preferred stocks are a solid and reasonably safe way to get extra income every month.

Disclaimer

I am not a professional investor or financial planner. The above are my personal thoughts and experiences and should not be taken as recommendations. Investors should perform due diligence and recall that prior performance is not predictive of future results.

I hold PGX, PFXF, PSF, SSW-H (SSW-PRH) and BRESV as preferred issues or ETFs in my portfolio.