Preferred Stocks

“For some time, I have been interested in lowering my exposure to the US equity market and I have been looking for interesting yield plays. This, as you know, is an area that is highly out of fashion. I have tried in vain to find a publication, or research, that specializes in preferred shares in America. I have found absolutely no research, newsletters, websites, chatrooms etc that offer insights to the preferred market (I even spoke to Mark Hulbert and he knew of no newsletters focusing on the area). A few focus on convertibles or convertible preferreds, but zero on old fashioned straight preferreds. From what I can tell it seems that there are a number of preferred shares issued by medium sized companies in the States offering pretty compelling yields. What I would like to find would be a quirky newsletter, brokerage house, or some resource that would offer insights. My gut tells me this is an area that offers compelling opportunity. Any thoughts?” — Tobias Brown

Preferred stock is not really like stock at all. You don’t own part of the company, you have just lent it money . . . often with no repayment date (!), just the promise of a dividend that will never go up (!!). Yes, some preferreds are convertible into common stock, so you may share some of the company’s good fortune,if it has any. But basically preferreds are like bonds, only they get in line behind bondholders in the event of a bankruptcy.

Because of the tax break preferreds give corporations but not individuals (most of a preferred dividend is free of corporate income tax), common sense would suggest –though not prove! — that preferreds would be bid up by corporations to reflect that tax advantage . . . and thus not be a terribly good value for those who can’t take advantage of it.

Then again, municipal bonds don’t seem adequately to reflect their tax advantages to high-bracket taxpayers these days. So maybe the market doesn’t work so rationally after all, and preferreds can be a better deal than common sense would suggest. (Likewise, municipals.)

And with preferreds getting so relatively little attention, who knows? There could be some good deals out there.

I don’t know of any newsletters or resources specializing in preferreds. Sorry. (Do any of you?)

But I say again: preferred dividends are fully taxed to individuals, and have to compete with Treasury bonds, which are (a) safer; (b) simpler; (c) often easier to trade without taking a haircut; (d) non-callable; (e) tied to specific maturities; (f) taxed at the federal level but free of state income tax. (And preferreds have to compete with municipal bonds, whose interest payments can be free of ALL income taxes.)

So I foresee no stampede toward preferreds.