Friday . . . On Tuesday of this week I added a preferred-stock exchange traded fund (ETF) to the Dividend Portfolio. It has low volatility, a low-expense ratio, it's not actively managed and so far the dividend contains no return of capital: nice and boring, that's what you like sometimes. With the dividend (we bought the day before the stock traded ex-dividend) and over 20 cents of price appreciation, the stock is already up some 1.56%.
Most people know that if you hold preferred stock you get paid before the common-share holders in the event of a bankruptcy or other dividend-eating horror. But there's more to know. Herewith a few facts and some definitions that should clear up any mysteries resulting from contact with words like "convertible" or "puttable" or other esoteric financial terms ending in "-ble."
Even though preferred stocks are listed on the balance sheet as equity, they're really more like bonds than common stock. Preferred stocks usually have a fixed dividend and carry no voting rights. They have priority over common stocks (but are subordinate to debtors) in the case of bankruptcy and with regard to dividends, but usually don't appreciate as a common stock does. Technically they have an unlimited life but are often redeemable.
Preferreds can be bought and sold just like common stocks. Companies that issue them often have more than one series, using letters of the alphabet to distinguish them, for example, Series A, Series B, etc. Depending on where you get your daily stock data, you'll find them listed either by the familiar ticker symbol followed by an underscore, the letter P and the series letter; or by the symbol followed by PR and the specific issue letter or by the symbol plus a lower-case "p" and the issue letter.
Many companies refrain from issuing preferred stock because it can be an expensive way to capitalize. Preferreds pay dividends, which come from after-tax profits, while bonds pay interest, which comes from pre-tax dollars. So preferreds are more costly because they don't get a tax break. But if you're a corporation (aha!), owning the preferred stocks of other companies is desirable since corporations are exempt from taxes on up to 80% of preferred dividend income. Sadly, plain individual investors are not. It's why preferreds are largely held by corporations, but that fact shouldn't prevent you from owning preferred stocks or a preferred-stock fund.
Some terms to know:
Cumulative: Most preferred issues are cumulative, meaning that dividends will accrue even if they're stopped for a time. In a crunch, preferred dividends may be suspended but once the dividends are resumed -- and before common dividends can be paid -- cumulative preferred shareholders must be paid their accrued dividends. (The opposite is "non-cumulative.")
Redeemable: Most preferreds are redeemable, or "callable," meaning the issuer has the right to redeem the shares after a stated date.
Participating/Non-participating: Great when you find them. Participating preferred shares may receive additional dividends based on a predetermined formula using the issuer's profits, the board of director's kind-heartedness, or some combination of the two. The participation dividend will be less than the amount paid to common shareholders, but this feature still adds value.
Convertible: Convertible preferreds can be exchanged for common stock at a set price after a certain date. In 1996, for example, Microsoft issued 12.5 million shares of 2.75% convertible, exchangeable, principal-protected preferred stock, each of which was converted in 1999 for 1.1273 common shares.
So if you're looking for low volatility and a virtually-certain cash return for your retirement portfolio, with more liquidity than a bond, preferred stocks or preferred stock funds could be what you need.
