Preferred shares are becomming surprisingly more attractive these days, even among retail investors.  One reason for the renewed interest is because of the world’s financial crisis, and a general mistrust of governments constant market rule changes.  Preferred shares are also being talked about almost daily on CNBC, especially for insolvent financial institutions that were deemed “to big to fail“, but not “to big to bailout“.   For insolvent financial institutions, it is readily believed that the common shareholders will eventually all be wiped out.  But with what seems like unlimited government backing (at taxpayers  expense, of course), investments in preferred stock may still come out ahead.


What is preferred stock? – From wikipedia,

Preferred stock, also called preferred shares or preference shares, is typically a ‘higher ranking’ stock than voting shares, and its terms are negotiated between the corporation and the investor.

Preferred stock usually carries no voting rights, but may carry superior priority over common stock in the payment of dividends and upon liquidation. Preferred stock may carry a dividend that is paid out prior to any dividends being paid to common stock holders. Preferred stock may have a convertibility feature into common stock. Preferred stockholders will be paid out in assets before common stockholders and after debt holders in bankruptcy. Terms of the preferred stock are stated in a “Certificate of Designation”.

Notice two important points from above:

  1. As more and more dividends are being wiped out in common shares, many preferred shares are still paying on them.
  2. Preferred shares have PRIORITY of payment over common shares.

There are some other key differences in preferred shares, as explained by this USAToday article.  First, dividends from preferred shares may not qualify for the lower dividend tax rate (currently 15%).  Second, investing in preferred shares can be confusing, because they are really like a mix of stocks and bonds.


Other advantages of preferred shares are less price volatility than common shares, and greater liquidity than corporate bonds.  Other disadvantages of preferred stock are lack of voting rights (if you care), interest rate sensitivity, and callability.

CNBC’s Karen Finerman (the smartest one on the Fast Money show) has announced she is using preferred shares in her hedge fund as a long/short strategy.  She mentioned she is LONG Bank of America preferred shares, and SHORT the common shares. For an explanation of the “long/short strategy”, check out the geldpress article on hidden jewel in the shorts.

Buying preferred shares is pretty straightforward and very similar to buying any other shares in common stock.  As for picking preferred shares, its a little trickier, and requires on specialty websites that host preferred share content, such as QuantumOnline (registration required).  And for those of you who like the idea of preferred, but simply can’t be bothered to pick among them, there are easier (although not necessarily better) methods, such as investing in the ishares U.S. Preferred shares index fund (symbol PFF).  Similar offerings may also be available at other brokerage institutions.

Finally, if you are serious about investing in preferred shares, there are some good books to help guide you.  I would recommend this recently released Preferreds as a start, by Ken Winans.

Preferreds
Preferreds by Ken Winans