There’s Something About Preferred Stock

Last fall, Warren Buffett made news with his multi-billion dollar investment in General Electric (Ticker: GE). Since his investment, GE’s shares have staged a steady decline from $25 per share into the single digit territory (view the chart).

Warren Buffett - Bridge @ Borsheims 2007, Photo by Ethan Bloch, Courtesy of flickr

But Mr. Buffett opted to purchase shares of preferred stock instead of common stock. Now, take a look at the chart which compares shares of GE’s common stock versus shares of GE’s preferred shares (Class A).

The preferred shares have suffered, but not nearly as much as the common shares. So what is it about preferred stock?

Preferred stock is often referred to as a hybrid security because its shares have the qualities of the two main asset classes: stocks and bonds.

Like common stock, preferred shares represent an ownership interest in a company. Preferred shares also pay dividends. In the case of liquidation, preferred shareholders are paid after bondholders, but before common shareholders. The preferred status also grants these shareholders the right to collect dividends before common shareholders.

Similar to bonds, preferred shares offer predetermined, periodic cash flows. Preferred dividends are usually set at a fixed amount or at a fixed percentage of the preferred stock’s par value. For an example, take a look at a quote for preferred shares of General Electric. Preferred shareholders do not have voting rights.

In a nutshell, preferred shares offer an investment in stock-sized proportions and a bond-like stream of payments.

There are two ways to make money from a long position in stock: capital gains and dividend income. Dividends from common stock are optional and adjustable. The inability to rely on these cash flows can add more risk to common shares.

Preferred stock prices tend not to fluctuate as much as common stock prices so you may not see a huge reward in capital gains, but the fixed income is a big benefit. Especially in a tough economic time like the present.

It appears there is something about preferred stock. Perhaps that something is predictable income.