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Research rules before buying preferred stock
|Personal Finance editor
© St. Petersburg Times
published December 1, 2002
Q. On my broker's recommendation, I have been purchasing preferred stock in lieu of investments in common stock or bonds. My question is why are these older, well-established companies issuing preferred stock at rates higher than current rates for loans? I always thought preferred stock was issued by companies just starting up in business and not having a history of earnings.
A. Established companies have been issuing preferred stock for many years. What's happened is that more investors have discovered preferreds as falling interest rates have sparked a search for higher yields. Companies have then come up with more preferred issues to tap into this increased demand.
Companies issue preferred stock because it is a good deal for them. The rates are often lower than the company could get on an unsecured loan. Also, in the weird world of corporate accounting, preferred stock generally is not recorded as debt on a company's balance sheet. That makes the company's financials look better than they would if the company borrowed the same amount of money from the bank. In addition, the shares are generally callable under certain conditions. That means that if interest rates fall, the company can redeem the stock and reissue new shares at lower rates. It is also the reason investors should be sure to find out the yield to call when they buy a preferred stock.
"If the new issues are coming out 6.75 to 7.25 percent and you have a current yield of 7.5 percent, typically you can expect it will be refinanced," said Greg Ghodsi, a broker with Robert W. Baird & Co. in Tampa. If you paid a premium for the shares, you could lose money.
You mention preferred stock issued by start-up companies with no history of earnings. That would be a very high-risk investment. Only buy or hold preferred stocks issued by companies that you expect to be able to make all dividend payments on time. If a company misses a dividend, it generally is obligated to make up the amount in the future. However, in many instances, an investor will be taxed on the dividend due even though it is not paid. If a company goes bankrupt, it may never be paid.
Q. Some years ago I found a book about corporations that sell stock directly to investors. Do any companies still provide this service? What are the advantages or disadvantages? Are any books available today?
A. Hundreds of companies offer this service. The main advantage is that you avoid a brokerage commission, although modest service fees are common. The main disadvantage is that you have no control over the price you get when you buy or sell. You send in your order and wait for the company to execute it.
I recommend direct investing to investors who want to make multiple purchases, particularly if they will be investing small amounts of money. For those who just want to save on brokerage commissions for a one-time purchase, I suggest using a discount broker.
Whether you use direct purchase or a broker, a regular stock purchase program gives you the benefit of dollar cost averaging. If you invest the same amount of money each time, you will buy more shares when prices are low. The down side of multiple purchases is that your tax situation becomes muddled if you fail to keep careful records.
If you want a book on the subject, your options include Guide to Direct Investment Plans, $27, (800) 388-9993 and Directory of Companies Offering Dividend Reinvestment Plans, $39.95 (301) 549-3939. Lots of free information is also available on the Internet. Go to www.wall-street.com and click on "direct stock purchase" under "U.S. links."
Former Sen. Bob Dole and the National Retirement Planning Commission he represents are on a mission to get Americans to focus on saving and investing the money they'll need to get through retirement. The commission's Web site (www.retireonyourterms.org) includes a retirement calculator and advice on selecting a financial adviser. The sponsors are organizations related to the financial services industry.
-- Helen Huntley writes about investing and markets for the Times. If you have a question about investments or personal finance, send it to On Money. We'll try to answer those we think are of greatest reader interest. All questions must be submitted in writing, but readers' names will not be published. Send questions to Helen Huntley, Times, P.O. Box 1121, St. Petersburg, FL 33731.