If you are an income investor, it could make sense for you to look into owning preferred shares. This is because for income and dividend investors, owning preferred shares has many benefits, most of which I cover below.
But other investors who want to limit their risk should also consider investing in preferred stock as well.
Truth be told, preferred shares make a lot of sense for many investors, but are often overlooked for common shares. By understanding the many benefits to preferred stocks, you could find a better investment option to complete your portfolio. You may sometimes see these in Motley Fool stock picks.
4 Reasons Why Preferred Stocks Are Smart Investments
#1. Fixed Dividend That Takes Precedence
When dividends are paid, preferred stock owners get paid before common shareowners. While most companies make it a point to distribute enough of a dividend to pay both preferred stockholders and common shareholders, there have been some instances when only preferred stock holders get paid a dividend.
So if you want to ensure that you do get paid a dividend when a company announces a dividend payment, be sure to own preferred stocks instead of common stock.
#2. Ability To Collect Unpaid Dividends
One great benefit of owning preferred stock is the ability to collect unpaid dividends. If a company suspends dividend payments for some reason, as a preferred stock holder, you can still collect the unpaid dividends when the company starts repaying dividends.
For example, if another financial crisis hits and a company stops paying their annual dividend of $2.00 per share for two years before restarting payment, you collect this unpaid dividend when they begin to pay again.
So if you own 100 shares, you will get paid $400 of the unpaid dividends and then the current $200 dividend as well.
This investing strategy can really pay off in time and allow your money to really work for you and not against you. However, not all companies offer this benefit on their preferred stock shares, so be sure to inquire about this before taking a position.
#3. Ability To Convert Shares
In some cases, preferred stock owners have the option to convert their shares into common shares. Given the benefits of preferred stock that I already mentioned, why would you want to convert your shares?
The main reason is if the preferred stock shares are selling at a premium compared to the common shares. For example, you might convert your preferred shares at $60 a piece and get common shares at $40 a piece. You will end up with more shares overall and can take advantage of a greater potential price appreciation than the preferred shares.
In other cases, companies will set a fixed conversion rate when you convert your preferred shares into common shares. In most cases, you end up with more common shares than preferred shares you traded in.
In addition to the above, there are other benefits to converting preferred shares into common shares, including potential higher liquidity.
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#4. Higher Claim Than Common Shareholders
When a company goes bankrupt, bondholders are first in line to try to collect they lost investment. All the way at the end of the line are common shareholders. And since there is never anything left for common shareholders to collect, they end up losing their entire investment.
Preferred stock owners though get in line after bondholders. While this does increase the likelihood of collecting, odds are preferred stock holders still won’t collect much. But at the end of the day, the closer you are to the front of the line, the better.
All told, there are many benefits to owning preferred stocks. The biggest ones for most investors is a larger dividend, ability to collect unpaid dividends, and the option to convert preferred stock shares to common shares.
Because of this, if these benefits interest you, then it is worth your time to research preferred stocks to see if they are a fit for your portfolio.