The Motley Fool: Looking for stable income? Consider preferred stock
Should you prefer preferred stock? Well, it isn’t for everyone, but it’s worth learning more about and considering.
Like common stock, shares of preferred stock represent partial ownership of a company. While they’re technically shares of stock, they behave much like bonds, carrying a fixed dividend. Preferred stock comes in many forms. There are traditional preferred shares, whose dividends are taxed at the 15 percent rate, and newer “hybrid” versions, often called “trust preferreds,” which are taxed at higher rates. Some preferred shares are convertible into cash or common stock — according to the will of the investor, the company or a formula. Preferred stock is often purchased by corporations because of the tax breaks they offer companies.
Preferred-stocks dividends are typically higher than their common-stock counterparts, attracting those who seek dividend income. While the Standard & Poor’s 500 index often sports an overall dividend yield of around 2 percent to 3 percent, and bonds tend to offer yields in the low to middle single digits, preferred shares typically offer yields in the high single digits, with some paying yields above 10 percent.
Another attraction relates to pecking order. In the event of corporate trouble such as bankruptcy, holders of preferred shares get to collect before holders of common stock. So while common stockholders often receive nothing if a company enters bankruptcy protection, preferred shareholders may end up with a few cents on the dollar. (Note that creditors take precedence over preferred stockholders, though.)
Is there a downside? Of course. Since preferred stock shares are bond-like, when interest rates rise, they can become less valuable. Preferred shareholders generally have no voting privileges. Their shares can be converted into cash or common stock at inopportune times. And preferred shares generally don’t appreciate in value as quickly as their common stock counterparts.
If you’re looking for stable income, learn more about preferred stock. But consider high-yielding common stock, too. You can learn about many contenders by trying (for free) our Motley Fool Income Investor newsletter at www.incomeinvestor.fool.com.
Ask the Fool
Q: I know what a 10-K report is, but what’s a “10-K 405”? — J.M., Tallahassee, Fla.
A: American (and Canadian) companies trading on U.S. stock exchanges have to file annual “10-K” reports with the Securities and Exchange Commission (SEC). They generally feature discussions of the company’s condition, audited financial statements, letters from management and glossy photos of happy employees and customers. When a 10-K report is filed late, it bears a 10-K 405 label.
In between 10-K reports, companies file quarterly 10-Q earnings reports. You’ll see an 8-K report filed when there is a significant development affecting the company’s financial condition
Learn more about SEC filings at www.sec.gov/answers/form10k.htm. Familiarity with them can help you become a better investor.
My dumbest investment
I used to day-trade Worldcom stock — not because I knew much about the company, but because it was a high-volume stock, always on the “most active” list. It typically traded in a range between $13 and $15, and the swings were consistent enough that I could buy low and sell high easily. I placed an order for 1,000 shares at $13 at the close of trading one day. I checked a few minutes later and saw it had been filled. The next morning, trading in the stock was suspended as the company began to implode. I hate it when that happens. — Jerry LaVergne, Arlington, Texas
The Fool Responds: Day-trading is risky. It’s estimated that 75 percent to 90 percent of day-traders lose most or all of their money. It’s more like gambling than investing, since day-traders tend to know very little about the companies behind the stocks they trade. Commission costs are a hurdle, too. If you trade 50 times a day and pay $10 per trade, you’ll need to earn $500 per day, or more than $100,000 per year, just to break even.