Investing Advice

Preferred Stock

When I was about 13 and first heard about “preferred stocks”, my initial thought was since preferred stocks pay a guaranteed dividend, why would anyone want just “common” stock?

But there is more to consider. Here is what you need to know about these stocks:

  • They look like stocks, but behave like bonds.
  • Their dividend never changes, but common share dividends can go up.
  • About 1,500 issues, most trade on the NYSE at about their original price, usually $25 or $50.
  • There are no voting rights with these shares.
  • If the company fails, preferred shareholders stand in line before common shareholders for any proceeds, but behind all creditors and bond-holders.
  • Companies can postpone paying promised dividends for up to 5 years, but you still have to pay income taxes on the accumulation.
  • They have a call date that gives the company a right to buy them back if current interest rates have dropped.
  • Since the dividend % was based on the original par value ($10, $25, $50, etc.), if the stock trades at a lower price, the current yield for new investors is higher. If the stock trades at a higher than par value price, the current yield for new stock purchasers is lower.
  • Like bonds, when interest rates fall, preferred shares become more attractive and investors will pay more for the shares. When interest rates rise, the yield doesn’t look so great compared to safe treasuries, so there is less demand for the shares and the price falls until the effective yield is high enough to be attractive.
  • I’ll repeat this last one in a simpler way, when interest rates go up, the share price will go down. When interest rates go down, the share price will go up - almost automatically.

Investors that buy preferred stock are generally the conservative type, who are looking for a steady dividend that may be higher than they can achieve with A-rated bonds.

Current yields range from 6% to 15%, depending on when the stock was issued and the credit-worthiness of the company.
 

Every month or so, the Federal Reserve Board's meeting makes business headlines. The market is usually quiet as investors wait for news about the direction of interest rates. A raise in rates sends stocks tumbling, and a drop in interest rates, especially a bigger than anticipated drop, will spark a huge rally. So what is this Federal Reserve thing all about?

The Federal Reserve Board's chairman is appointed by the President and confirmed by the Senate, and many board members are principals of New York investment banks. The Fed oversees the Federal Reserve Banking System which is made up of 12 regional banks that distribute paper money and act as a check clearing house for your local bank. Its most visible function is its influence on the economy by setting monetary policy, manipulating the money supply, by raising or lowering key interest rates. The Fed funds rate is the one watched by investors and the news media. This is the rate banks charge one another for overnight loans to cover their minimum cash-reserve requirements.

The discount rate, generally 1/2% less than the funds rate, is the interest rate that banks pay the Federal Reserve for short-term loans.

Lower interest rates put more cheap money into the banking system, increasing the amount available to lend to consumers and businesses. Lower interest rates also encourage consumers to spend, and businesses to borrow for expansion creating more jobs. This boost to the economy is usually felt about six months after a change in interest rates.

The Fed raises interest rates to cool a "too hot" economy and keep inflation in check. They drop rates to stimulate the economy. In 2001, the Fed dropped rates a record 11 times to 1.75%, down from 6.5%. Learn more, including the Fed's history at www.federalreserve.org

Other Stock Market Basics Topics:

  1. Stock Market Basics
  2. Why invest in the stock market?
  3. Why Sell Stock?
  4. How are shares bought and sold on the NASDAQ?
  5. How stocks are traded on the New York Stock Exchange
  6. What are ECNs?
  7. Supply and Demand
  8. American Stock Exchanges
  9. International Stock Exchange
  10. What fuels demand for a stock?
  11. More to Know About Stock Trading
  12. Limit Orders
  13. Market Capitalization
  14. Preferred Stock
  15. How to Buy Stock?
  16. How much money do you need to open a brokerage account?
  17. Money Market Funds
  18. Margin Loans and Investment
  19. Corporation Executive Pay
  20. How much money do you need to open a brokerage account?

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