How Preferred Are Preferred Stocks?

by David Jenyns on October 9, 2009

In an attempt to combine the most attractive features of bonds and common stock, financial experts created “preferred stock.” Preferred stock generally involves far fewer shares than the common, and far less money than is represented by bonds.

Preferred stock may also be convertible into common stock of the company at a stipulated ratio. Because this is an attractive feature for investors, it often means that the issue may carry a lower dividend rate than would otherwise be expected.

If you should buy a convertible preferred, however, see whether it is protected against dilution of the common. Each share is now $30. And each preferred share, instead of being worth $180, is worth only $60 when converted. Stock dividends, rights, and mergers may also alter the conversion ratio.

Fortunately, company intentions are fairly predictable, for preferreds, being a fixed-interest item, are also tied to money rates. The risk to a callable preferred, therefore, is a period of cheap money. Preferred stock might not be a big money-maker, but its returns are generally better than bonds.

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