Personal Finance: Preferred stocks pay attractive dividends

Personal Finance: Preferred stocks pay attractive dividends

May 16th, 2012 Travis Flenniken in Business Diary

Preferred stocks are an asset class with which many investors aren't too familiar. Relative to common stocks, the preferred stock market is small, with most issuances coming from real estate investment trusts, banks, utilities and insurance companies.

Preferred stocks typically have odd hyphenated ticker symbols that aren't as easy to decipher and may vary based on different online trading applications. For example, to check CBL & Associates Properties Inc.'s C-series preferred stock price, one may need to use the ticker CBL+C, CBL-PC, CBL.PC, or CBL.C depending on which website is used to get a price quote.

Many preferred stocks pay attractive dividends and demonstrate less price volatility than common stocks.

In today's low-rate environment fraught with macroeconomic uncertainties, preferred stocks may be a good investment option for individuals looking to capture a competitive yield and be less susceptible to the inherent risks of common stocks.

However, an investor can get quickly burned in a preferred stock if he or she doesn't understand the basics of each one they buy.

Preferred stock is considered to be a hybrid security of a common stock and a bond. A preferred stock may appreciate in price such as a stock; but actually it is more like a bond because its primary form of return to the investor is the income it produces and because it has an expiration date.

Preferred stocks are considered to have less risk than common stocks because they have higher priority to the earnings and the liquidation value to the company. As a result, preferred stockholders must receive their dividends before common shareholders.

In some cases, preferred stockholders are the only recipient of a dividend.

In general, the preferred stock investor is ultimately choosing current income over price appreciation. A common stockholder's upside is theoretically unlimited, but a preferred stockholder, unless convertible to common, will have less upside.

Companies typically pay a significantly higher dividend to preferred shareholders than to common. Many investors, wary of the current economic client, prefer to have the income today, rather than hope that their returns are realized in the future.

Most preferred stocks are issued at $25 per share, which is also their call price. The issuer maintains the right to "call" or buy back the preferred stock after a certain date, which is stated in the issuing company's prospectus. Preferred stocks often appreciate in price, but not significantly higher than the call price, especially when nearing the call date.

Investors should be absolutely certain of the call date for a preferred stock before purchasing. If an investor buys a preferred stock at any price above $25 per share (the typical call price) near or after the call date, he or she risks the security being purchased back by the issuer, creating an immediate loss. Having a security forcibly sold back to the issuer at a lower price than purchased is known as call risk. Call risk can be averted if the investor takes the time to examine the terms of the preferred stock in the security's prospectus.

Preferred stocks can be a great way to generate investment income, but one must understand the rules of the game as provided for in the somewhat-tedious pages of a company's prospectus to prevent costly mistakes that otherwise could be avoided.

Get answers to financial questions on Wednesdays from our columnists who work in the financial services industry. Travis Flenniken is a certified financial analyst with Campbell Asset Management LLC. Submit questions to his attention by writing to Business Editor Dave Flessner, Chattanooga Times Free Press, P.O. Box 1447, Chattanooga, TN 37401-1447, or by emailing him at dflessner@timesfreepress.com.