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Buying Preferred Stocks My Way

April 20th, 2014 at 04:34 pm

Three years ago, all my investment capital was in common stocks. Then, about a year ago, I ran into a dry spell where I could not find any common stocks to add to my portfolio* with the cash that was piling up from dividends and profit-taking stock sales. So I started looking into preferred shares as a way to fill out my portfolio. Here is how I handled that.

I practice a high-yield, high-risk income investing strategy.** That means in part that I have selected the common stocks that I have bought for my portfolio screening in for the highest possible dividend percentage payout, and then screening out from the resulting list those stocks whose issuing companies fail my own particular set of financial performance criteria.** But evaluating preferred shares requires an additional level of scrutiny.

What I learned about preferred shares boils down to this. They are issued by most companies at a set face value price, usually either $25 or $100. They carry a fixed percentage dividend yield that cannot be changed or cancelled (unlike common stocks). And the payment of this preferred stock dividend takes precedence over the payment of any dividend on common stocks (which simply means that preferred stock holders get paid first). But there is still more.

Preferred shares can be "callable" (that is, redeemable) at any time by the issuing company at the company's sole discretion and for a price that has been stipulated at the time the preferred shares were originally issued. Preferred stock can also be "convertible" (that is, exchangeable) into common stock shares at the sole discretion of the issuing company at a predetermined time. And preferred stock dividends can be "cummulative" (that is, accruable) which means that, if a preferred dividend is skipped by the company for any reason, that skipped dividend remains due and must be paid before any other dividends are declared.

With that information in hand, my buying criteria for preferred shares (over and above my core buying criteria**) became very clear. Never buy preferred shares that are not cummulative because I want every chance of actually collecting my dividends. Never buy preferred shares above their issue price because if I do I am certain to lose money if the company calls in those shares. And never, never, never buy preferred shares that are convertible to common stock because the chances of getting shafted on that deal are way too high.

Other than that, it is easy-peasy. I screen for higher-yielding preferred shares. I then check each share issue against my three preferred share never-nevers. Once those special hurdles are cleared, I make sure there is still room in my portfolio for the industry the issuing company is in.*** If that looks okay, then I run the issuing company through my standard business model review and four-hurdle financial criteria gauntlet** just like I would with common stock shares. And if all still looks good, then I put in a buy order for the preferred shares and lock in their dividends until and unless I am later able to sell at a 10% or better profit.****

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* Why I Only Buy Dividend Stocks:
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** My High Yield, High Risk Investing:
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*** Stock Diversification My Way:
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**** What Makes Me Sell a Stock?:
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