Preferred Stock 101+Sheaff Briefs Editor
(Quick Preferred Stock “cheat sheet” coaching session for those “in the know,” but who could use a little reminder before investing):
Companies raise capital by either borrowing money or by selling ownership. To accomplish that goal, they issue either debt or equity securities. As an alternative, by issuing preferred stock, a company combines the characteristics of both debt and equity. There are some advantages to a company that issues preferred securities:
- Issuing preferred stock as opposed to bonds keeps the company’s debt-to-equity ratio lower, a situation favored by investors.
- Ratings agencies tend to give a more favorable analysis for preferreds as opposed to bonds.
- Preferred dividends may be suspended if needed without forcing the company into bankruptcy giving the company some cash flow flexibility.
Advantages to individual investors when choosing preferred stock:
- Yields on preferreds tend to be higher than those on bonds, money market funds, or common stock.
- Preferred stock has low correlations with common stock (preferreds can be considered a good way to diversify risk).
- Many preferred stock distributions are classified as “qualified dividends,” which are taxed at capital gains rates.
There are two general ways of measuring the yield on preferred stock:
- Current yield—the annual dividends divided by the current price of the security.
- Yield to call—the yield if the security is called.
Some types of Preferred Stock:
At Sheaff Brock, we believe active management is key in investing in preferred stock. The Sheaff Brock Preferred Income portfolio consists largely of $25 par retail preferred securities with the addition of some $1,000 institutional preferred stock. There are many factors to consider when managing the portfolio such as:
- credit rating
- yield to call
- option-adjusted spread
Sheaff Brock Senior Portfolio Manager JR Humphreys agrees that diversification is always an important factor in building a portfolio. Top holdings in the Sheaff Brock Preferred Income portfolio represent a variety of sectors, including finance, real estate, global and U.S. banking, credit services, and utilities, with the overriding goal being to generate consistent income while seeking preservation of capital, Humphreys stresses.