QUESTION: I'm just thinking about investing in the stock market and am trying to understand all the choices available to me. One obvious choice is preferred stock instead of common shares. Can you explain the differences? Should I buy preferred stock instead of common stock?--J. C.
ANSWER: Under most circumstances, the experts say, the individual investor interested in playing the "upside potential" of the stock market is better off buying common stock rather than preferred. Still, for the conservative, extremely cautious investor, who doesn't mind the fact that preferred shares typically don't have voting rights, this type of stock offers a reliable dividend flow that is almost always higher than that paid on common shares.
One expert likens preferred stock to a "demilitarized zone" between common stocks and bonds. Like most common stock, preferred shares pay a quarterly dividend. But, unlike the dividends of common stock, the preferred dividend is fixed and usually does not fluctuate with the financial fortunes of the company. In this respect, preferred shares function much like bonds, providing the holder with a fixed and steady income flow.
Although the fixed flow and generally high yields may appeal to the cautious investor, the investor forgoes the opportunity to cash in on a company's fortunes, if indeed they should rise. Unlike with common shares, prices of preferred shares generally don't fluctuate with the company's performance. Instead, they tend to rise and fall with the gyrations of interest rates. And, if a company does well and decides to share its riches with its shareholders, typically it's the common shareholders, and only they, who benefit. (Remember, preferred share dividends are fixed.)
Still, let's take at look at the origin of "preferred" shares. As the name implies, these shareholders are preferred to common shareholders, which means that these stockholders are entitled to dividends even if common shareholders are forced to forgo theirs if business sours.
There are different types of preferred shares. Among the more popular variations are "cumulative preferred" and "convertible preferred." To protect shareholders, most preferred shares are cumulative, which means that in the event dividends cannot be paid, the company's obligation to pay them continues and the amount of dividends owed accumulates. When the company's fortunes improve, all owed dividends must be paid to preferred shareholders before common shareholders receive anything.
This "cumulative" aspect has attracted some investors to preferred shares at companies where dividends have been suspended and are accumulating. Shares where preferred dividends are in arrears gain a certain cachet when it appears that a company is about to emerge from its woes. If and when the company resumes dividend payments, current cumulative preferred shareholders are entitled to all the back payments, whether or not they owned the stock during the period of suspended payments.
It can be a quite a windfall. Bethlehem Steel announced in April that it would pay $22.5 million in suspended dividends and resume the regular quarterly dividend on its two classes of preferred stock. The trick to playing the cumulative game, of course, is to pick troubled, not terminal, companies.
Another popular class of preferred stock is the convertible type of shares. These shares can be traded in for common shares at a specified price. These offer the holder the opportunity to profit if a company's common shares start to soar and are popular among companies trying to interest the more cautious investor in a newer, more speculative venture or business market.
Typically, the standard "no frills" preferred shares have appealed to corporate investors because corporations--unlike individuals--may exclude 70% of their dividends from taxation. Many corporations find it hard to argue with a fixed, steady income with a 70% tax loophole. Because of the tax exclusion, experts say prices of some of these shares have been bid up to the point that they make not make much sense to the individual investor who does not enjoy the same tax break.
Q: What can we do to reduce the fees and costs associated with refinancing a home?--H. L.
A: Your first step should be a call to the lending institution now financing your home. Clearly, your current lender knows you, and if you have been a credit-worthy borrower, you should have some clout. Your current lender might not want to lose your business and may offer you the most attractive refinancing package you can find. Further, because you have already qualified as a credit-worthy borrower for your current lender, the process may be less costly and time consuming than at some other institution.