Preferred Stock vs Common Stock

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Preferred Stock vs Common Stock

Postby ps56k » Fri Feb 08, 2013 1:27 am

Was just reading about Apple and a potential push for some form of preferred stock as a way to distrib the existing cash balance.

Since all we have ever had is common stock, I had to read up on the differences.
So, are there any Vanguard funds that target preferred stock and use it almost like a fixed income fund ?
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Re: Preferred Stock vs Common Stock

Postby DaveS » Fri Feb 08, 2013 4:12 am

There is a preferred stock ETF. I cant remember if it's I shares or something else. I can't believe Apple would seriously issue preferred stock. Generally issuers are troubled companies that pay out a "preferred" dividend because they can't raise capital any other way. The stock usually has a call feature that limits the appreciation possibilities to preferred stock holders. If the company issuing the preferred stock get's out of trouble, they just redeem the preferred share class at par, or convert it to common stock, so you don't participate in any upside from the company getting turned around. Insurance companies have some tax or similar preference if they hold preferred stock. Thus insurance companies are the biggest buyers of preferred stock. Swedroe and other advisers tell ordinary investors to stay away from preferred stock. Dave
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Re: Preferred Stock vs Common Stock

Postby ps56k » Fri Feb 08, 2013 8:54 am

I see that there are several ETFs that address this type of stock, and I was just curious, because of the recent news on Apple.

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On Thursday, hedge fund manager David Einhorn sued Apple in a New York federal court in an effort to block an Apple shareholder proposal that he argues could limit how the company could return some of its $137 billion cash pile to investors. Apple is proposing to require a shareholder vote before it can issue preferred stock, a kind of security that Mr. Einhorn is urging the company to adopt. Apple's board already has the right to issue such shares, but said in a filing it doesn't intend to do so.
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Re: Preferred Stock vs Common Stock

Postby larryswedroe » Fri Feb 08, 2013 11:20 am

Not a fan of preferred stocks for variety of reasons. There is chapter on them in my book The Only Guide You'll Ever Need for Alternative Investments, I put them in the flawed category, along with high yields and convertibles. Among the reasons are the asymmetric risks similar to junk due to calls. Another is that yields are impacted by dthe demand from corporate buyers who get a tax break (which you don't)
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Re: Preferred Stock vs Common Stock

Postby baw703916 » Fri Feb 08, 2013 11:33 am

larryswedroe wrote: Another [reason] is that yields are impacted by the demand from corporate buyers who get a tax break (which you don't)
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I was wondering why the efficient market wouldn't take care of this! Thanks for anticipating the question.

Best wishes,
Brad
Most of my posts assume no behavioral errors.
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Re: Preferred Stock vs Common Stock

Postby Karamatsu » Sat Feb 09, 2013 6:10 am

There are a lot of funds that focus on preferred stock. Most seem to use the CEF structure but there are also some ETFs. The biggest are PFF and PGX. I can't help thinking this is a dangerous time to buy into them, though. Larry Swedroe's book has a good run-down on the dangers, and I think at this point there is a very real risk that, as rates rise, you'd end up stuck with a lot of below-market issues that you'd either have to hold forever at the low yield or sell at a loss. Buyer beware...
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Re: Preferred Stock vs Common Stock

Postby nisiprius » Sat Feb 09, 2013 9:15 am

Once upon a time Vanguard did have a preferred stock mutual fund, but it was closed and liquidated in 2001.

It's funny, you never hear about preferred stock any more. Apparently it is sort of an historical curiosity at this point and not used except by... what was ValueThinker saying... a few financial companies as part of some complicated strategy. In addition to what Larry says, from my own naïve point of view I've just filed it away as "weird stuff I don't need to know about." And as part of the "neither fish, flesh, fowl nor good red herring" stuff, the stuff that's in between stocks and bonds, your safer stocks and your riskier bonds. The burden of proof is always on the person who claims that there's something magically wonderful about these chimeras that makes them far better somehow than just adjusting the balance between plain old stocks and plain old bonds to get the risk you want.

When I was a kid, though, in the 1950s and 1960s, ordinary financial discussions usually used the phrase "common stocks," not just "stocks," because preferred stocks were, uh, common enough that it was important to be clear about what you were talking about. I have no idea why, but all the stuff targeted at novices and laypersons ALWAYS made a point of explaining the difference. When I was in, was it sixth grade, and went on a field trip to New York to visit the Morgan Library and the Stock Exchange, the guide explained the difference between preferred stocks and common stocks. I remember that. I remember the Gutenberg Bible in the Morgan library. I remember a conference room at the NYSE that had the most amazingly thick carpet I have EVER seen, it really seemed to be four or five inches deep, I mean it was a little hard to walk on it was so thick. Oh, yes, we also visited the Federal Reserve and I was quite impressed by seeing a million dollars in one-dollar bills piled on a fairly ordinary-looking table.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
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Re: Preferred Stock vs Common Stock

Postby Karamatsu » Sun Feb 10, 2013 10:17 pm

It all depends on what pond you swim in. Preferred stock gets touted a lot by those aiming at income investors, and they do have some nice features. They're the original exchange-traded structured products. I was actually surprised recently to see that banks and pseudo-banks are still offering them, but the latest issues have coupon rates of 5% or so for a BBB rated company. With multi-decade maturities (some are even perpetual), when rates rise people will be stuck with those rates forever, with no opportunity to re-invest their principal at the higher yield. But I guess the market must think it's a good deal or they wouldn't be able to get any buyers.

There's always a bit of dissonance on that point. We pretend to that the market is efficient and a good assessor of risk-adjusted-return for the things we like, yet think the market is foolish in its evaluation of stuff we don't like. But despite the contradiction I still don't like them.
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