With the recent stock market crash a fresh and painful memory many investors have sought ways to protect their investments as they go forward. Some ask how to invest in preferred stock as a means of guaranteeing dividend payments, for example. Preferred stocks are special equities that fall in between debt instruments such as bonds and common stocks.
Knowing how to invest in preferred stock is important if the individual wishes to have preference over common stock holders in the payment of dividends. In fact, many times a preferred stock holder is entitled to cumulative dividends. That is, if dividend stocks do not pay dividends for several quarters they must not only pay holders of preferred stock their dividends first but must also pay all past dividends. How to invest in preferred stock is no different from investing in common stock. Preferred stocks are listed on major stock exchanges. An individual buys a preferred stock through a broker.
As we see, how to invest in preferred stock is not so difficult. However, how to invest in preferred stock and do it successfully is another matter. As we noted above, a preferred stock falls between a common stock and a bond. In case of a company going bankrupt bond holders have a preferential right to assets over holders of preferred stocks and holders of preferred stocks have a preferred right over holders of common stock.
Looking forward someone purchasing preferred stock needs to know that holders of preferred stocks do not have the voting rights that common stock holders have. More importantly for many is that while a common stock will commonly appreciate in value over the years the value of a preferred stock is commonly tied to the interest payment the holder receives. Thus, when interest rates go up the value of a preferred stock goes down.
This is the same in the case of corporate bonds. However, corporate bonds have an expiration date so that the discount on the bond decreases as expiration approaches and the bond holder receives full payment at expiration. This is not the case with preferred stocks as they are typically held in perpetuity.
They remain discounted so long as interest rates remain above those when the preferred stock was issued. As with all stock purchases the investor needs to do diligent fundamental analysis of the stock as well as interest rate conditions before buying.
How to invest in preferred stock successfully means carefully reading the terms of the preferred stock in its certificate of designation. These terms will tell the investor about terms of dividend payment, rights of the company to redeem the preferred stock, the degree of priority that the preferred stock has over common stock in the same company. These terms may also include the ability of the preferred stock holder to convert to common stock in the same company or in an affiliated company.
For many who invest in preferred stock this is the bottom line, the ability to hold shares with a preferred hold on company assets when the company is in trouble and the right to convert to common stock when the company rebounds. What makes you a successful investor is often the ability to spot opportunities such as that of buying preferred stock, with a convertibility option, at the right time.