Preferred Shares

Preferred stocks combine characteristics of common stocks and bonds. Garden-variety preferred shares are a lot like general obligation bonds/debentures; they are called shares, but carry with them a set dividend, much like the interest on a bond. Preferred shares also do not normally vote, which distinguishes them from the common shares. While today there are a lot of different kinds of hybrid preferred issues, such as a call on the gold production of Freeport McMoran Copper and Gold to the point where they will deliver it, this article will consider characteristics of the most ordinary variety of preferred shares.

In general, a preferred has a fixed dividend (as a bond pays interest), a redemption price (as a bond), and perhaps a redemption date (like a bond). Unlike a stock, it normally does not participate in the appreciation (or drop) of the common stock (it trades like a bond). Preferreds can be thought of as the lowest-possible grade bonds. The big point is that the dividend must be paid from after-tax
money, making them a very expensive form of capitalization.

One difference from bonds is that in liquidation (e.g. following bankruptcy), bond holder claims have priority over preferred shares, which in turn have priority over common shares (in that sense, the preferred shares are "preferred"). These shares are also preferred (hence the name) with respect to payment of dividends, while common shares may have a rising, falling or omitted dividends. Normally a common dividend may not be paid unless the preferred shares are fully paid. In many cases (sometimes called "cumulative preferred"), not only must the current preferred dividend be paid, but also any missed preferred dividends (from earlier time periods) must be made up before any common dividend may be paid. (My father once got about a $70 arrearage paid just because Jimmy Ling wanted to pay a $0.10 dividend on his common LTV shares.)

Basically, preferreds stand between the bonds and the common shares in the pecking order. So if a company goes bankrupt, and the bond holders get paid off, the preferreds have next call on the assets - and unless they get something, the common shareholders don't either.

Some preferred shares also carry with them a conversion privilege (and hence may be called "convertible preferred"), normally at a fixed number of shares of common per share of preferred. If the value of the common shares into which a preferred share may be converted is low, the preferred will perform price-wise as if it were a bond; that is often the case soon after issue. If, however, the common shares rise in value enough, the value of the preferred will be determined more by the conversion feature than by its value as a pseudo-bond. Thus, convertible preferred might perform like a bond early in its life (and its value as a pseudo-bond will be a floor under its price) and, if all goes well, as a (multiple of) common stock later in its life when the conversion value governs.

And as time has gone on, even more elaborate variations have been introduced. The primary reason is that a firm can tailor its cost of funds between that of the common stock and bonds by tailoring a preferred issue. But it isn't a bond on the books - and it costs more than common stock.

In general, you won't find a lot of information on the preferred shares anywhere. Since they are in a never-never land, it is hard to analyze them (they are usually somewhere low on the equity worth scale from the common and bonds). So they can't really carry a P/E and the like. Unfortunately, most come with the equivalent of the bonds indenture - that is the "fine print" and you may have to get and read it to see just what you have. (I once had preferreds that paid dividends in more shares of itself and in shares of another preferred, but how Interco got itself into bankruptcy is another story.)

There are other reasons why preferreds are issued and purchased. A lot of convertibles are held by people who want to participate in the rise of a hot company, but want to be insulated from a drop should it not work out. Here's a different strategy. For example, I've got some Williams Brothers Preferreds. They pay about 8.5% and are callable in Fall, 1997. When I bought them (some years ago), they had just been issued and were unrated (likely still are not). But Williams itself is a well-run company with strong cash flow that then needed the money fast to buy out a customer who was in trouble. So I bought these shares more as I'd buy a CD. The yield is high, the firm solid - and likely they will pull my investment out from under me someday. Meanwhile, it forms a bit of my "ready cash" account. And I can always sell it if I want to.

Problem is, with so many variants, there isn't always a preferred that you'd want to buy at the current price to carry out some specific strategy. Naturally, not every firm has them, the issues are often thinly traded and may not trade on the exchange of the parent firms common (or even be listed on any exchange).

If the preferred shares get called (i.e., converted), you normally collect just as if common shares are bought out - in cash, no deduction.

 Price Data

Many people have asked me "how can I get the closing price for stock XY on date Z." A common variant is to get the close of the Dow Jones Industrial Average (or other stock index) for some given date or range. The answer is that you need to find a provider of historical data (also called historical quotes). If all you need is the open, high, low, close, and volume for a stock on some date, you're in luck, because this is available at no charge on the web (see below). However, if you want detailed data suitable for detailed analysis, such as the full report of every trade, you probably will have to pay for it.

Yahoo Finance offers historical stock price data. To get the data, find the current symbol for the security and use Yahoo Finance to get the latest quote. Then look in the left-hand column for a link to "Historical Prices" and click on it. At the bottom of the page you'll find a link to download the data in spreadsheet (comma-separated value, or .csv) format. You can retrieve data for stock indexes if you find the appropriate symbol; for example, Yahoo currently uses "^DJI" for the Dow Jones Industrial Average. However, if the stock is not currently traded, it appears that Yahoo doesn't offer the data.

Here's a link to the Yahoo Finance page:
http://finance.yahoo.com/

Repurchasing by Companies

Companies may repurchase their own stock on the open market, usually common shares, for many reasons. In theory, the buyback should not be a short term fix to the stock price but a rational use of cash, implying that a company's best investment alternative is to buy back its stock. Normally these purchases are done with free cash flow, but not always. What happens is that if earnings stay constant, the reduced number of shares will result in higher earnings per share, which all else being equal will result, should result, in a higher stock price.

But note that there is a difference between announcing a buyback and actually buying back stock. Just the announcement usually helps the stock price, but what really counts is that they actually buy back stock. Just don't be fooled into believing that all "announced share buybacks" are actually implemented. Some are announced just for the short term bounce that usually comes with the announcement. Those types of companies I would avoid as management is out to deceive their shareholders.

Exchange-Traded Funds and Unit Investment Trusts

An exchange-traded fund, also known as a unit investment trust, is a collection of securities such as stocks or bonds that are bundled together in a special vehicle that happens to be a trust. Investors can buy tiny little pieces of the trust ("units"). So although a UIT looks like a mutual fund in that it bundles things together and sells shares, the units are listed on an exchange and trade just like stocks. Exchange-traded funds are usually set up to mirror a well-known stock index. The most well-known example is the Standard & Poors Depositary Receipt (SPDR, see below).

A UIT that mimics some index is in many ways directly comparable to an index mutual fund. Like an index fund, it's diversified and always fully invested. Like a stock, you can buy or sell a UIT at any time (not just at the end of the trading day like a fund). And for the serious traders out there, you can short many UITs on a downtick, which you cannot do with stocks.

Below is a list of some of the common UITs/ETFs out there. All of these are created by large financial institutions, and usually (but not always) charge modest annual expenses to investors, commonly 0.2% (20 basis points) or less. Any commissions paid to buy or sell them are paid to a broker, of course.

 •UIT that mimics the NASDAQ 100 Index, commonly called a Qube. Trades as QQQ on the AmEx and has a value of approximately 2.5% of the NASDAQ 100 index. As of this writing, the trust has about $12 billion. More information is available from the NASDAQ:
http://www.nasdaq-100.com/indexshares/nasdaq100_intro.stm
     •UIT that mimics the Dow Jones Industrial Average. Named the Dow Industrial Average Model New Depositary Shares, commonly called DIAMONDS. Trades as DIA on the AmEx and has a value of approximately 1% of the DJIA. More information is available from the AmEx:
http://www.amex.com/?href=/etf/EtMain.jsp
     •UIT that mimics the S&P 500. Named a Standard & Poors Depositary Receipt (SPDR), commonly called a Spider or Spyder. Trades as SPY on the AmEx and has a value of approximately 10% of the S&P 500 index. As of this writing, the trust has nearly $18 billion. More information is available from the AmEx:
http://www.amex.com/?href=/etf/EtMain.jsp
      •Select sector SPDRs - these slice and dice the S&P 500 in various ways, such as technology companies (symbol XLK), utilities (XLU), etc. All are traded on the AmEx. More information is available from this site:
http://www.spdrindex.com/
      •Some companies offer ETFs that do not mirror a well-known index, but instead are proprietary to that company. One example is Vanguard's Index Participation Equity Receipts(VIPERS); more information about those is available at http://www.vanguard.com
The following resources offer additional information about exchange-traded funds and UITs.

ETF Simplified offers a beginner's guide to investing with exchange-traded funds.

http://etfsimplified.com/

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