With the market looking dicey, this might be a good time to consider preferred stocks.

More like bonds than common stocks, preferreds offer steady income, but not much appreciation potential. But that income might be high enough to get you interested. Many preferreds are paying dividends equating to 5% to 7% yields (annual dividend income divided by your cost), and sometimes higher.

Here are some things that you need to know about preferreds. 

About Preferred Stocks
Although traded like common stocks, preferreds represent debt, not ownership. However, unlike bonds, a firm may suspend payment of its preferred dividends without filing for bankruptcy. Thus, priority number one when buying preferreds is to make sure that the issuing company has the ability to keep paying its preferred dividends.

When it sells preferreds, the issuing firm sets the issue price, most often $25, and the annual dividend (usually paid quarterly), which typically remains fixed for the life of the preferred. The initial dividend yields (coupon rate) typically range from 4% to 7%, however I’ve seen some as high as 9% issued by relatively solid companies.

Because preferreds trade on the open market, share prices vary with supply and demand. When trading below the IPO price, the yield to new investors (market yield) moves above the original coupon rate, and vice versa. Usually, preferred share prices trade close to their issue price. For instance, a preferred issued at $25 will typically trade in the $23 to $27 range depending on market conditions.

Most preferreds are “callable” meaning that the issuer has the right to call (redeem) them at the “call price,” which is usually at, or slightly higher than the original issue price. The shares can be called at any time after the “call date,” which is typically five years after the IPO date. Firms don’t have to call their preferreds on the call date and many preferreds are not called for years after their call dates.

Finding Preferreds
Quantum Online (www.quantumonline.com), a free site, is the best resource for finding and researching preferreds. You can use Quantum’s screener to find preferreds suiting your needs. Find it by selecting Income Tables on the main menu and then the Income Securities Screening Form. It’s easy to use and Quantum provides explanatory material for each screening choice.

Once you’ve used the screen to generate a list of candidates, click on each ticker symbol to see Quantum’s description of that preferred. The descriptions look dense, but they are readable and you can click on any term with a link to see Quantum’s definition of that term.

Evaluating Preferreds
Quantum doesn’t give you the current trading price. For that, you’ll need to refer to other sources. Unfortunately, unlike common stocks, preferred ticker symbols are not standardized and vary from site to site and broker to broker. However, Microsoft Money (money.msn.com) and TDAmeritrade (www.tdameritrade.com) use the same symbols as Quantum, so I would start with those. You don’t have to be a TDAmeritrade customer to get basic information on preferreds. Simply use the Quotes box on its homepage. When you’re ready to buy, use your broker’s symbol lookup function.

Check the current trading price and recent daily trading volume on either MSN Money or TDAmeritrade. Avoid preferreds trading less than 5,000 shares daily. TDAmeritrade displays the market yield based on the current trading price.

Assuming that a firm continues to pay its preferred dividends, the worst case for a preferred investor, in terms of total return, is that your preferreds get called on the call date. “Yield to call” is the average annual return you would earn should that happen.

You can use the Bond Yield Calculator on MoneyChimp (moneychimp.com) to determine yield to call. Your minimum acceptable yield to call depends on your preferences. I use 5%.

Besides for the preferreds themselves, you must also research the issuing company to determine that has the wherewithal to continue paying the dividends. I don’t have room to cover that here, but as a rule of thumb, avoiding preferreds issued by firms whose common stocks trading below $15 per share will keep you out of trouble.

For more on evaluating preferreds, check the Preferred Stocks section of my Dividend Detective site (www.dividenddetective.com).

Preferred Ideas
Here are four preferreds that look interesting to me. 

• Ashford Hospitality Trust 9.0% Series E Cumulative (ticker AHT-E): issue price $25.00, recent price $25.10. Market yield 9.0%, yield to call 9.0%.

• BB&T Capital Trust VI 9.60% (BBT-B): issue price $25.00, recent price $26.59. Current yield 9.0%, YTC 7.3%.

• JP Morgan Chase Capital XXIX 6.70% Capital Securities (JPM-C): issue price $25.00, recent price $25.92. Market yield 6.5%, YTC 5.6%.

• Public Storage 6.50% Cumulative Series P (PSA-P): issue price $25.00, recent price $25.66. Market yield 6.3%, YTC 5.8%.  

Preferreds have no value if the issuing company can’t come up with the cash to pay the dividends. So, do your due diligence. As is always the case in the market, the more you know about your stocks, the better your results.

published 6/5/11