Within the enormous spectrum of financial tools, preferred stocks occupy a special position. These stocks are technically equity securities though they share key characteristics with several debt instruments. Some financial analysts rightly refer to them as Hybrid Securities. This article provides a detailed overview of the stocks and relates them with other known investment vehicles in the market. Further, it avails to you appropriate options of preferred stocks to choose from as an investor.
Common stocks, bonds and preferred stocks have shared traits and differences. An investor who intents to learn about preferreds, must be interested to find out on the stock’s seniority, relative to its rivals. It is right for investors to note that bonds enjoy a higher ranking than preferred stocks. Meaning when an investing company pays dividends, bonds are considered ahead of preferred. In listing the stocks in their respective order of liquidity, preferred stocks take second position after bonds. Commons stocks occupy final stand. That is an advantage to both bonds and preferred shares. A common character in the investment vehicles that give an investor greater insight into the preferreds’ pros and cons is stock convertibility.
Preferred stocks, just like convertible bonds, can easily be transformed to common stocks of the issuing company. The feature permits investors, to lock in the fixed return from preferred dividends. At the same time it makes it possible for traders to participate in the capital appreciation of common stocks without any limitation.
On interest rate sensitivity, preferred shares – issued at par value-have their interest based on the par and are fixed like bonds. However, the market value of the preferred is not as sensitive to deviations of interest rates as bonds. A product whose interest rates are highly sensitive to market charges are favorable only if high profits are made but if losses are made, a negative balance reflects on the investor’s financial position-to a greater extent. Maturity of preferred stocks is not fixed. They have unlimited life. But still they can be called by the issuer after a specific period. Just like bonds, the company would call the preferreds only if it pays a higher rate than what the market currently offers.
A key difference to record between bonds and preferred, concerns information accessibility. As opposed to bonds, information about a company’s preferred shares is easily accessible to an average investor .This makes preferred easy to trade in. Also par values are not identical in each case. Bonds usually trade at par values ranging averagely at $1,000 and minimum purchase amounts of five bonds .This is higher to preferreds’ par.
Now look at examples of preferred stocks and discover how each of them fits your business needs. A common type of preferred shares in the market is the cumulative preferred. What it means to an investor to have cumulative shares is, if the company withholds expected dividends in part or in full, then they are considered dividends in arrears. They have to be paid for before any other dividend is paid at any given time. Preferred with no cumulative features are called either straight or non-cumulative preferred shares. The next is a type of preferred that is very convenient to shareholders with plans to trade in other stocks but holding only on the preferred stocks .This is the convertible preferred. For the stock, timing for conversion and conversion prices specific to the share is laid out in the shares’ prospect.
Another investment tool to consider in the same category is participating stock. If a company issues participating preferred, then those stocks have the potential to earn higher dividends than the amount stated. However most preferred are non-participating. The new model commonly called Adjustable-rate Preferred Stock (ARPS) is also equally good example to provide. ARPS’s dividends are dependent on U.S. government issues. They provide the investor with limited protection against negative interest rates in the market. They are very rewarding especially if traded in by experts or informed persons.
Finally, remember that the preferreds have numerous advantages. Despite a few of its weaknesses, the stocks remain to offer good profit making options. And with the current legal backup, a lot of success is expected among the shareholders. IRS rule gives opportunities to American corporations that pay corporate income taxes to exempt 70% of their dividend income from taxable income. This is a capital plus for institutional investors. Individuals are not left out. They too stand to benefit, but much better after tax advice.