How you can benefit from regular distributions with preferred stocks
If you want to generate income via the stock market, you might want to look into preferred stocks. These high-dividend stocks offer a relatively (!) safe option, regular income without having to do anything for it. They also impress with low volatility. Nevertheless, preferred stocks are still hardly known in Germany.
On this page, I explain what exactly the term means, what advantages and disadvantages I see, what tips I have for you and how I invest myself.
Preferred stocks - a hybrid between preference shares and corporate bonds
Preferred stocks or preferred shares literally translate as preference shares - but are actually much more than that. In Germany, for example, we have preferred shares in Volkswagen or Henkel. These promise a higher dividend than ordinary shares, in return, the shareholder waives their voting rights. In fact, preferred stocks, which are mainly issued in the USA, have a few more interesting features - which is why we are sticking with the English term.
First of all, when the preferred stock is issued, a fixed dividend is fixed. As a rule, this is 4 - 7 %. This means that you already know how much dividend you can expect when you buy, similar to interest on bonds. The issue price is standardized at USD 25. So here you have a nominal value with which you can compare the current market price in order to recognize an over- or undervaluation. In addition, the issuer usually secures a repurchase right after three to five years. Please note: This is only a right, not an obligation. Preferred stocks are therefore part of a company's equity and are traded on the stock exchange. Nevertheless, they also clearly have the character of bonds, which is why they are known as hybrid securities or mezzanine capital. For me, they are simply high dividend securities for the more defensive part of the portfolio.
Preference shareholders have the right to dividends before ordinary shareholders. If the former go away empty-handed, the latter can still be served. The payouts are usually made every quarter and may only be suspended if the company's earning power is insufficient. In contrast to bonds, where a default on interest is very likely to result in the insolvency of the company, the suspension of dividends on preferred stocks does not have to be permanent. On the contrary, as you will see in a moment, payments are often made up as soon as the company is in a better financial position.
In detail, there are also differences within the class of preferred stocks. to consider. In my view, the following four are the most important:
1. nominal fixed dividend (= fixed percentage) OR Linking the dividend to a defined interest rate (= variable variable percentage ratecalculated according to a formula) - this will of course pay off if interest rates rise again as expected
2. "Cumulative" preferred stock, where suspended payments are made up as soon as as soon as possible, OR "Noncumulative" or "Straight" Preferred Stock, where there is no right to subsequent payment in the event of dividend defaults
3. unrestricted repurchase right by the issuer at any time OR only after a defined date ("callability") AND / OR fundamental maturity date (maturity date) of the preferred stock on which the shares must be redeemed (Note: In reality, most preferred stocks run for significantly longer than the callability allows, as this flexible redemption is a key advantage of the financial instrument from the company's perspective)
4. Convertibility of the preferred stock into ordinary shares ("convertibility to common stock") or no convertibility
Advantages and disadvantages of preferred stock
What makes preferred stocks so interesting? The main argument is certainly the strong Dividende. If you want to earn part of your income through distributions, you have good reason to hope for regular payments with low price fluctuations.
This low volatility is the positive side of the redemption right of preferred stocks. Since from a risk point of view you have to expect that the issuer will buy back the shares at the issue price, it is simply not worth paying more than this price. Conversely, significantly lower prices can only be expected if the company is facing insolvency. However, the chance of price appreciation is offset by the risk of total loss.
Another nice side effect for you as an investor is that you can - normally - assume a high probability of being paid for your your preferred stocks on the market at around the original price at all times. at any time. If you want to sell your cash position position in the short term, this is a great thing, as you will receive a dividend yield in the meantime dividend yield that no savings account can match. This investment therefore offers relatively good liquidity, even though the securities have a lower trading volume than other high-dividend stocks (e.g. REITs).
If you're thinking "Wait a minute, but some preferred shares are currently trading well below USD 25", you're absolutely right. The expected rise in interest rates is currently putting a lot of pressure on prices. I explain why this is the case below!
If a company does have to be liquidated, as a shareholder of preferred stocks you are still ahead of the "normal" shareholders in the queue for a final payment. Of course, you should avoid this if possible - you can find ideas for reducing risk in my tips below!
High dividends, low costs, stable share prices - what's the other side of the coin? As always, this is there and needs to be described so that you can make the right investment decisions for you.
First enemy of the preferred stock is the inflation. As the dividend is absolutely fixed, it effectively loses value with inflation. Nevertheless, a nominal yield of 5 - 6 % is of course still better than making losses with no interest at all on the call money account.
Speaking of interest: High interest rates are basically the biggest risk for preferred stock investors. This is good to see at the moment. Because if I can also get bonds with high interest rates on the market, where the security is simply even higher than with preferred stocks, I am naturally inclined to move my money there. In the same way, hardly any issuer has an interest in buying back the shares in this market situation - after all, they will no longer be able to obtain financing so cheaply. Consequently, the market price of preferred stocks falls when interest rates rise. And unlike the interest coupons of a bond, dividends on preferred shares are not enforceable. If the company is unable to pay, you have to bear this as a shareholder.
Another important difference to bonds: When interest rates rise, bond prices also go down, but you get back the nominal value on the fixed redemption date. Accordingly, you may only be able to sell in advance with a price loss, but alternatively you can simply hold the bond until maturity. In the case of preferred shares, it can take a very long time for prices to recover or the issuer decides to buy them back. This jeopardizes the actual character of a security that can be liquidated quickly without loss. If you are unlucky, even for a very long time. The issuer is probably pleased that he still has securities in circulation for which he has to pay less interest than would be the case in an interest rate environment that has risen in the meantime. The issuer may therefore be unable to repurchase the shares for an indefinite period, as he has the right, but not the obligation, to redeem the shares after the call date.
In fact, it has probably already happened that companies have bought back their shares anyway in order to escape the pressure from institutional investors. However, I would not necessarily bet my money on this.
And on the market, it could also become more difficult for some preferreds to find a buyer. Just imagine the issuer of a preferred share wants to issue new shares now. He will only get paid the 25 USD nominal value if he adjusts his interest rate to the rising market rate. So why would someone buy the (old) share from you at 5% interest when they can now have a (new) share at 7%?
Looking at the stock market at the moment, it must be clearly stated that quality also pays off with preferred shares. Conservative, covered stocks without much risk in the portfolio hold their nominal price much better than others.
If interest rates tend to fall or remain consistently low, the company's call option, i.e. the right to buy back preferred stocks, is also a fact that should be kept in mind for financial planning. It may sometimes be necessary to restructure your investment without planning. However, this right is often not exercised at all or only much later. And as long as you get at least your purchase price back, you can cope with it.
Of course, you should also not forget the basic currency risk. The investment in American preferred stocks is logically made in US dollars and your income will vary accordingly with currency fluctuations. If the exchange rate goes against you during the investment period, the nice dividend may even turn into a loss if you look at the whole thing in your home currency.
6 tips for investing in preferred stocks
- Security selection 1As always, the risk of investing can be reduced through collective investments. While a single company can go bankrupt, the total failure of several assets is very unlikely.
- Security selection 2Companies that issue preferred shares often do so in more than just one version. It is not uncommon for there to be different versions with regard to the dividend amount or the four sub-categories mentioned above. Therefore, always check carefully which security is the most attractive for you and which one you order in the end! The usual stock exchange abbreviations in the USA differ only minimally.
- Order: Always order with a limit! As the securities are not traded in high volumes, the price can quickly jump. This risk can easily be limited by placing a limit order.
- Holding period: Due to the relatively fixed price, a preferred stock has little growth potential for the share price. share price. Even if the issuer does not buy back the securities, it makes sense to reconsider the investment after a certain holding period.
- TaxesFortunately, US dependency is not a tax issue. Like all capital gains, withholding tax of 15% applies, but this is fully creditable in Germany in accordance with the double taxation agreement and is usually offset directly by the broker. If you are unsure about this, check again whether your broker does this.
- Speaking of brokerDepending on which securities you want to invest in, your standard broker may not have them in their portfolio. Because preferred stocks are so little known here, some people simply find it too much effort. But fortunately they do exist. For example, I use the ARMO broker. If you open a free securities account via my link, there are special conditions! You can trade US shares for just 2 USD - a great offer. An ETF on preferred stocks is also easily available from Scalable Capital.
