What Is A Preferred Stock?

Bill Parrott |

Preferred stocks can generate significant income and are hybrid investments, similar to stocks and bonds. The dividend income is usually higher than owning shares of common stock, and you may get some price appreciation. The preferred label comes from the pecking order on the balance sheet because shareholders receive their dividends before common-stock owners. In a corporate liquidation, bondholders receive their money first, followed by preferred holders, and common-stock shareholders receive whatever is leftover.

Preferred shares are typically issued at $25 per share and can't be called or redeemed by the issuer before five years. If a preferred does get called, it's at $25 per share.

The price of preferred stocks hovers around $25, and they may trade to $28 or $30 per share if rates are falling. When rates rise, the price may fall to $20 or $21 per share. They're sensitive to interest rates, like bonds, and the prices adjust up or down based on the level of interest rates. Earning an income of six percent or more from preferred stocks is possible.

Preferred stocks are rated like bonds, so invest in ones with quality ratings. Standard & Poor's and Moody's apply ratings from AAA to D, depending on the quality of the issue. It's rare to find AAA-rated preferred stocks; most ratings fall between BB and B . Ratings don't tell the whole story, as we discovered in 2008, so pay attention to corporate balance sheets. During the Great Recession, several preferred stocks fell in price to single digits. Preferred stocks are sold with a prospectus, so you can read about all the features before purchasing your shares.

On the surface, a preferred stock sounds like a solid investment; however, the devil is in the details. As I mentioned, most preferred stocks get called after five years. If you purchased one intending to get your money back after five years, and it is not redeemed, you may hold your shares for thirty, forty, or fifty years or more!

Of course, you can sell your investment anytime, but you may get more or less than your purchase price. It is a risk for investors when interest rates rise because the value of your shares can fall. You can likely sell your holdings for a gain when interest rates drop.

Barron's has a tremendous section of preferred stocks. In the stock tables, you can look for companies by name, price, yield, etc. Once you have identified a few, you can do further research online.

I recommend allocating approximately five percent of your fixed-income portfolio to preferred stocks if you want to give it a boost,

What do you prefer? ~ 1 Corinthians 4:21

March 3, 2023

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM's custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on your asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren't suitable for every investor. Prices and yields are for today only and are subject to change without notice.