Preferred Stocks - What's In A Name?
Sometimes a name can tell you a lot and sometimes a name doesnít exactly convey the essence of its subject. The latter is the case with preferred stocks. Like common stock, preferred stock is a type of share that a company can issue in the stock market. While it does have some rights and features, a preferred stock describes a hybrid security that is a fixed income investment and not an investment for appreciation. Over the years, people have developed a misconception as to the benefits and drawbacks in owning preferred stocks. Some of the things to consider when contemplating a purchase of preferred stocks are stock dividends, the benefits and disadvantages of preferred stocks and the reasons to own them.
Preferred stocks usually pay a fixed rate dividend; this feature makes it very similar to a corporate bond. Preferred stock does have first claim to dividends as well as assets of the corporation in the event of liquidation. Because of what was seen as a positive, fixed investment, many people involved with long term investing sought out preferred stocks for a consistent return on investment. As companies have struggled with profitability over the past decade, they have frequently chosen to reduce or eliminate dividends in cost-cutting maneuvers, eliminating the most attractive benefit of preferred stocks.
In addition, preferred stocks do not afford their holder rights of voting and they do not appreciate like common stocks do. Preferred stocks are usually bought by companies that can use their tax advantages to avoid much of the taxes on the dividends.
Benefits of Preferred Stocks
Individuals have the right to own and benefit from preferred stocks, but understand that you need to be very careful because not all shares and investment options are equal. Many preferred stocks are callable which means that if market prices fall, the company can call the shares. You will receive your money back, but will have to reinvest at new, lower rates. In addition, preferred shares may carry different restrictions and qualifications that vary from company to company. Before you buy preferred stocks, it is wise to acquire stock market advice by meeting with your tax or financial consultant to verify that you are eligible for the 15 percent dividend tax benefit or if they will be considered ordinary income.
Are There Good Reasons to Own Preferred Stocks?
For the average investor, buying preferred stocks may not be the best investment advice. Although they have drawbacks as well, bonds have similar benefits to preferred stocks and they also feature a fixed income since they are guaranteed by the bondís indenture. As companies look for cost cutting opportunities, their dividends become potential targets, undermining their appeal. It is important for someone involved in defensive investing to look at each companyís dividend payout history for at least ten years to verify that the company hasnít been using dividend cuts to improve their bottom line or to fund cost-cutting.
If you are completely informed on a particular preferred stock and have been diligent with your fundamental analysis, there is nothing wrong with owning preferred stocks; however, many investors would suggest that there are better investments that deserve your analysis time. There are simply too many other options, including high quality bonds, high-paying money market accounts, common stocks, options and futures that are far less complicated and provide more potential benefits than preferred stocks. The preferential treatment that many investors expect from preferred stocks and no longer available and good, profitable investments can be found in other vehicles.