Buying Preferential Treatment

Looking for higher yields? A hybrid offered by blue-chip companies might be your solution

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Is the bond investor in you yearning for higher yields? Are you a bit disappointed that Treasuries top out at 6.5%, and only if you lock into a 30-year bond? Then, it might well be time to step away from Uncle Sam and back to corporate America.

That’s because preferred stock could well be the fixed- income answer you’ve been looking for. Simply put, preferred shares are a hybrid security offered by companies large and small, something of a cross between bonds and common stock. As an investor, you buy and hold shares of a corporation — AT&T to name one — and receive a fixed dividend each quarter much as you would with many common stocks.

There are a couple of basic differences, though. For one, preferred stockholders don’t enjoy the voting rights that common shareholders do. You can’t elect company board members or weigh in on matters such as mergers and acquisitions. But for giving up electoral powers, you’re handsomely compensated. The preferred shares of companies with stellar AAA credit ratings are yielding about 7.25%-7.5%, yet are considered only slightly riskier than U.S. Treasury notes. And, if you’re willing to take on riskier corporations with credit ratings of BBB, you’ll get a yield as high as 8%-8.875%.

Although preferred stock may not come with rock solid backing, it offers safeguards. Dividends on preferred stock must be paid before they can be paid on common shares. Also, most preferred stock provide for cumulative dividends. That means any dividends not paid to preferred holders in previous periods must be doled out before common stock dividends are paid, says Kelvin Walker, an investment banker with Mesirow Financial in Atlanta. And, it’s good to know that preferred holders get precedent over common holders when it comes to payment of dividends and liquidation of assets.
All in all, that makes preferred securities a solid bet for individuals seeking a steady income stream and better-than-average dividends.

Purchasing preferred shares is as easy as buying ordinary shares. The market for preferred shares is active and liquid — $28 billion in traditional preferred stock was issued last year. Quotes often appear in the daily paper so you can monitor your holding. And, as a bonus, you’ll often find that preferred shares can appreciate in value. Interestingly, though, preferred stock is typically a lot less volatile than common stock, whose price can plummet due to anything from bad news from the company to a downgrade from a Wall Street analyst. In contrast, preferred stock usually moves only if the credit rating of the issuing company changes or when interest rates swing.

One cautionary note: there are all kinds of exotic new preferred shares. You’ll hear talk of trust preferreds and adjustable rate preferreds. Another new wrinkle is convertible preferreds, which can be exchanged for common shares at the owner’s option and without putting up additional funds. Unlike plain-vanilla preferred stock, convertible preferred sells at a price close to the market value of the common stock and tends to move in tandem with the common.

Kevin Brooks,

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