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Common Stock vs. Preferred Stock

We’ve all heard the terms common and preferred stock. Are the common shares for retail, Blue Collar Investors while the preferred shares for the Wall Street insiders? Not exactly. They are both types of stock that a corporation may issue. Let’s clarify the difference.

Definitions:

Common Stock– This is a security that represents ownership in a corporation. It allows you to elect members of a Board of Directors and vote on corporate policy. This is the first type of stock a corporation would issue. Not all corporations issue preferred stock.

Preferred Stock (also called preferreds) – This is a class of ownership in a corporation that has a higher claim on the assets and earnings than common stock. It is usually associated with a dividend that must be paid before dividends to common shareholders (that’s us) and these shares do NOT have standard voting rights. The structure of preferred stock is specific to each corporation. It differs from common stock in that it contains characteristics of both debt (fixed dividends) and equity (appreciation potential). These shares are established by companies that already have common shares and are intended for investors who are more interested in income than capital appreciation- the same type of investors who may otherwise purchase bonds.

Advantages of Common Stock:

  • Voting rights
  • Outperform bonds and preferred shares in the long run
  • Easy to manage without an expert
  • Can be used for covered call writing
  • Free information is easily accessible

Advantages of Preferred Stock:

  • Preference over common shareholders in receiving dividends
  • Preference over common shareholders with liquidation rights
  • Dividend rights are often cumulative (if unpaid one year, it is made up at a later date)
  • Most have a negotiated fixed dividend amount
  • Many have a convertible feature wherein they can be traded for common shares
  • Good compromise between common stocks and bonds
  • Liquidity- most trade in round lots of 100 shares on the NYSE and NASDAQ
  • Tax advantages- currently taxed @ 15% (as opposed to ordinary income), part of Busch tax reduction which may expire on December 31, 2010.

 

Disadvantages of Preferred Stock:

  • Minimal voting rights (only in unusual circumstances like a merger)
  • Callability– most preferreds can be called at a specified price after a certain date that may leave us looking for a replacement investment in a declining interest rate environment.
  • Interest rate risk- value will rise and fall with changes in interest rates, similar to longer term bonds.
  • Credit risk- if a company’s fundamentals decline an issuer may eliminate a preferred dividend before defaulting on debt.

Practical Application:

It is relatively easy to access both fundamental and technical information when evaluating common shares. This is not the case with preferred shares. First of all, there is no official preferred stock rating system as there is with bonds. You need to ascertain if the company is financially healthy and where it stands with respect to cash. We need to know that it has the cash to pay us those dividends. To evaluate this, we look at the company’s financial ratios like the interest coverage ratio. This will tell us how easily a company can pay interest on outstanding debt. A free site that will give some information related to this subject is:

www.quantumonline.com

Furthermore, symbols are tricky, data is hard to locate and many brokers do not specialize in this area. For most retail investors interested in investing in preferred shares locating a broker knowledgeable in this arena may be the safest route to take. Schwab (www.schwab.com) has a good reputation in this regard.

How to locate a list of preferred stock from the IBD website:

IBD- Get Preferred Stock List 

1- Go to IBD Homepage (www.investors.com

2- Look to “My Routine” Box on upper right 

3- If “other IBD data” is not in this box, click on “modify” 

4- Move “other IBD data” from “categories box” to “my routine” box 

5- Click on “other IBD data” 

6- Click on “futures options and other data” 

7- Scroll down to list of preferred stock 

8- Use the magnifier at the top toolbar to increase the size of the print (I use 400x)

Conclusion:

One of the mission statements of Blue Collar Investing is to be (more than) well-informed before investing your hard-earned money. Whether you are writing covered calls, purchasing preferred shares, equities or bonds, you must know and understand the product and the risks associated with them. Covered call writing is my passion but preferred shares offer a hybrid investment between stocks and bonds that may be appropriate for some investors.

Event update:

I will be presenting a FREE seminar on Tuesday July 12th @ 7PM for the Long Island Stock Traders Meetup Group. The topic is “Using Covered Call Writing to Increase Dividend Yield of High Dividend Yield Stocks”. You do not need to be a member of this club to attend. It will be held in a huge state-of-the-art auditorium at The Plainview-Old Bethpage Public Library:

999 Old Country Road

Plainview, NY 11803

Hope to see you there.

Market tone:

The market had a stellar week with predominantly negative economic reports. Go figure!:

  • The Conference Board’s index of consumer confidence dipped to its lowest level since November
  • Construction spending fell 0.6% in May
  • Consumer spending was flat in May after a 0.3% rise in April.
  • The ISM manufacturing index rose more than expected in June climbing from 53.5 in May to 55.3

For the week, the S&P 500 jumped 5.6% for a year-to-date return of 7.6%.

A 3-month chart of the S&P 500 compared with the VIX shows a sideways moving market and a declining VIX but in an uncomfortable volatile manner:

The S&P 500 vs. the VIX as of 7-2-11

 Note the following:

  • The S&P 500 has been flat @ + 0%- red arrow
  • The S&P 500 has been up 2.5% and down 5% during this 3-month time frame- yellow highlighted area
  • The VIX is down 8% in the past 3 months- green arrow
  • The VIX has been up as much as 30% and as down as much as 15%- red lines 

Summary:

IBD: Uptrend resumes

BCI: This site remains cautiously bullish but favoring mainly in-the-money strikes because of the volatility highlighted in the chart above.

A happy and healthy holiday weekend to one and all,

Alan and Linda and the BCI team (alan@thebluecollarinvestor.com)

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

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37 Responses to “Common Stock vs. Preferred Stock”

  1. Barry B July 3, 2011 1:58 am #

    Premium Members,

    The Weekly Report has been uploaded to the Premium web site.

    Best,

    Barry

  2. admin July 3, 2011 5:47 am #

    EZPW:

    Even pawn shops can be great covered call candidates. This company has been aggressively acquiring stores and now has a presence in 16 states and Mexico with 1000 stores and 500 short-term loan stores in the US and Canada.

    On April21st EZPW reported a stellar earnings report with sales up 19% and earnings projections of 30% and 17.5% for 2011 and 2012. A member of our premium watch list for 9 consecutive weeks, we see an industry segment rank of “A” and a beta of 1.45. Check to see if this security deserves a place of your watch list.

    Alan

  3. Jay July 3, 2011 9:12 am #

    Hi Alan

    I am planning to add some bonds to my covered call portfolio. What do you think about buying the TLT and writing OTM calls to generate additional 1-2% per quarter in addition to the yield of 4.4%, for a total of 8 -12% yield per annum?

    Jay

  4. Barbara July 3, 2011 11:50 am #

    Alan,

    When a stock is removed from your weekly list, when is it re-screened again to check to see if it should be put back in and does that mean we should automatically sell the stock?

    Thank you

    Barbara

  5. owenCPA July 3, 2011 1:15 pm #

    Barbara #4,

    Absolutely not. The stock’s removal from the list simply means that it no longer meets the criteria we have set for buying it, and selling a covered call. It should suggest that you keep an eye on your position, just in case the original premise for your trade begins to change.

    Remember, we enter trades, generally, for a four week period. The premium list is reviewed every week. We have two weeks left before the July expirations. If your position is still performing as you hoped it would when you entered it, then, by all means, continue to hold it. If the stock is beginning to show signs of weakness, and you think your deal may not make it to July 15, then you should consider closing it.

  6. owenCPA July 3, 2011 1:39 pm #

    I know I will sound like a broken record, but, as with earnings, net income, stock prices, bond prices, real estate prices, etc., it is important that you LOOK BEHIND THE CURTAIN!

    The net income of a business includes a deduction for interest paid on bonds. So, Company A decides to issue $200 million in bonds paying 4% interest. They will be reducing their net income by $800,000 each year those bonds are out. Since many investors use earnings per share (EPS) as a major guide for their decisions, this can have a serious impact on the company’s stock price.

    Ok, so Company A decides to sell $200 million in preferred shares that pay 4%. They are obligated to pay the same $800,000, however, the dividend is not an expense and the EPS will be higher than if they had sold debt, instead. Sounds good, but it also means that the income tax they may pay will be higher because the preferred dividend is not a deductible expense.

    Convertible preferred also has some need for scrutiny. WHEN can it be converted? HOW MANY shares of common will you get? WHAT is the current stock price? Remember, a convertible will rise and fall on the value of the stock it can be converted into, as well as the yield of the dividend it pays.

    The only thing black ans white in the stock market is the newspaper showing you yesterday’s prices. Everything requires some knowledge of bahavior before you jump into it. I learned everything I could about skydiving BEFORE I made my first jump. While that did not asure me that my first jump would not be my last, it did markedly increase the odds in my favor.

    Also, if you decide some preferreds are in your best interest, you might consider a mutal fund or ETF that is a preferred stock fund. Like common stock, it is better to spread your risk out. Remember, some people still own Enron preferred shares.

  7. admin July 3, 2011 2:09 pm #

    Jay (#3),

    In my view this is a reasonable and well thought out approach for those looking to combine bonds and covered call writing in their portfolios. As a matter of fact, TLT has been a periodic “visitor” to our weekly premium ETF report. Good stuff!

    Alan

  8. owenCPA July 3, 2011 5:01 pm #

    Jay (#3),

    I agree with Alan, however, like all concentrated ETFs, TLT can be moved by some market conditions. August 2 is, theoretically, the drop dead date for raising the debt ceiling or the US is in big trouble. Remember, bond values rise and fall inversely with interest rates. If interest rates go down, the bonds, and the bond funds, will go up. If interest rates go up, the bonds, and the bond funds, will go down.

    Interest rates really cannot fall much further, but they can go up if the risk associated with owning US Treasuries rises, as in, we aren’t raising the debt ceiling. I am going to consider your suggestion, because I think it is a good one, but I think I will wait until Congress gets its head out of …… ok, the sand.

  9. Fran July 3, 2011 9:28 pm #

    Alan,

    Can you explain the listing “HFC-HOC” on this weeks stock list.

    Thank you.

    Fran

  10. Barry B July 3, 2011 9:39 pm #

    Fran (#9),

    The company, Holly Corp…symbol HOC…merged with Frontier Oil this week and the new entity is trading under the symbol HFC. Since the symbol HOC will not be used going forward, I wanted to bring it to the attention of subscribers that might have been trading HOC and not have it disappear.

    Best,

    Barry

  11. Steve July 4, 2011 11:28 am #

    Alan,

    Is it too late in the July contract period to use your mid contract unwind exit strategy? If not, when is the cut off?

    Thanks

    Steve

  12. admin July 4, 2011 11:47 am #

    ACN:

    I mentioned this stock in last week’s blog commentary when it was announced that it would be added to the S&P 500. I have more good news about this equity which is a member of our premium watch list:

    On June 23rd the company announced its 5th consecutive positive earnings surprise. Revenues rose by 21% and earnings by 27%. Corporate guidance was increased to a projected revenue growth of 15%. Operating income rose 18% year-over-year. The balance sheet boasts a cash balance of $5 billion with no long-term debt. The return on invested capital (ROIC) is a remarkable 57% compared to its industry average of 8.5%. There’s more!

    ACN continues to buy back shares and generate a dividend of 1.5%. Despite the recent share price increase, ACN trades at a reasonable forward PE of 16.1 compared to its industry average of 19.7. Check to see if this equity deserves a spot on your watch list.

    Alan

  13. owen July 4, 2011 12:04 pm #

    Steve (#11),

    There is no “cutoff”, per se. There are two weeks left in the regular July option cycle. If you can find a profitable position, take it. Just remember the math, 1% for two weeks is the same as 2% for four weeks. Don’t get greedy and try for 2% or 3% by July 15th.

    As for the actual “cutoff” for trading the July options, it is, in reality, 4:00PM on Friday, July 15. If you feel you can make money between 2:00PM and the end of trading on the 15th you are free to enter the trade. Realistically, for the BCI, entering a trade on the 15th is probably not going to pay off, but you can do so.

  14. owen July 5, 2011 9:38 am #

    Jay (#3),

    Here is another slant on Treasury bonds.

    http://www.cnbc.com/id/43628669

  15. Karen July 5, 2011 1:22 pm #

    When a stock appears on your premium list in bold several weeks in a row (like EZPW) does that become a stock we should give stronger consideration?

    Thanks.

    Karen

  16. admin July 5, 2011 1:48 pm #

    PLCM:

    This stock has been a member of our premium watch list for the past 8 weeks. Today it underwent a 2-for-1 stock split and your portfolios should be adjusted accordingly if you own this equity. For example if you purchased 200 shares @ $60 (cost basis) that needs to be adjusted to 400 shares @ $30.

    Alan

  17. admin July 5, 2011 2:46 pm #

    Karen (#15),

    A stock in bold means that it has passed all screens plus confirming technicals. This IS a sign of strength especially if it occurs in multiple weeks. However, other factors like portfolio diversification, stock volatility as it relates to your risk tolerance and available cash are some of the other factors that also need to be considered.

    Alan

  18. admin July 6, 2011 6:43 am #

    Stock Selection:

    I’ve had several off-site inquiries about the process to select stocks from a premium running list with many choices like we’ve had the past 2 weeks. Here is a typical response:

    This is a good problem! Everyone has their own methodology but I’m happy to share some of the discerning factors I use:

    1- Favor the stocks in bold

    2- Favor stocks with the highest industry ranking

    3- Favor stocks that have been on the premium watch list for multiple weeks

    4- Make sure there is proper industry diversification

    5- Stock price fits my portfolio size (a $50 k portfolio should not have a $200 stock in it)

    6- Calculations- Multiple tab of the Ellman Calculator

    #s 1 and 2 are the most important to me.

    Alan

  19. Fred July 6, 2011 10:49 am #

    Anyone have any thoughts on SKYY a new cloud-based ETF?

  20. Amy July 6, 2011 11:34 am #

    They were talking about this etf on cnbc this morning. NFLX is the biggest holding.

    Happy trading.

    Amy

  21. Barry B July 6, 2011 11:45 am #

    Fred & Amy,

    I haven’t seen the companies in the SKYY portfolio…but…I’m in that industry and it is exploding! I’ve been in leading edge technology for over 35 years and know the business very well.

    Before you do anything, review the portfolio companies, send me the list, and I can give you commentary on those companies.

    Best,

    Barry

  22. Amy July 6, 2011 12:00 pm #

    The top components are as follows: NetFlix Inc. (NASDAQ: NFLX) 4.46%; RightNow Technologies Inc. (NASDAQ: RNOW) 4.15%; Open Text Corp. (NASDAQ: OTEX) 4.13%; Rackspace Hosting Inc. (NYSE: RAX) 4.11%; TIBCO Software Inc. (NASDAQ: TIBX) 3.91%; Informatica Corp. (NASDAQ: INFA) 3.89%; Acme Packet Inc. (NASDAQ: APKT) 3.87%; Teradata Corp. (NYSE: TDC) 3.80%; Aruba Networks Inc. (NASDAQ: ARUN) 3.78%; and Equinix Inc. (NASDAQ: EQIX) 3.70%. The classification stresses software at 32.53%, Internet software & services as 22.61%, communications equipment at 16.75%, and computer & peripherals at 11.15%.

  23. admin July 6, 2011 1:21 pm #

    Speaking of NFLX, Meriman Capital downgraded this company today and then set a price target of $300 – $330…some downgrade!

    I never get concerned about a single analyst downgrade.

    Alan

  24. Barry B July 6, 2011 3:17 pm #

    Amy (#22),

    All good companies…I compete with some of them. As you can see, many of them are on the Premium Watch List or have recently been on the Premium Report Watch List. I like this ETF.

    Best,

    Barry

  25. Barry B July 6, 2011 3:20 pm #

    re: SKYY…

    I tried to get an option quote…no quotes. I was able to get a price quote but no chart. How new is this ETF?

    Barry

  26. Barry B July 6, 2011 3:23 pm #

    re: SKYY

    This must be a brand new ETF. I went to ETF Trends…one of the better ETF sites and they didn’t have a listing.

    Barry

  27. admin July 6, 2011 3:55 pm #

    SKYY:

    Today is the first day of trading which explains the lack of information.

    Alan

  28. owenCPA July 6, 2011 4:56 pm #

    Ok, I just want to be sure I understand this. Sony’s internet gaming was hacked. They were shut down for weeks. They lost millions of customer credit card numbers.

    Now, let’s substitute “Google” for the “Sony” in the sentence above, and substitute the word “business” for the word “gaming”. Oh, and just for good measure, let’s throw in the week or two, Reddit, Foursquare and a bunch of other business were out of business because Amazon’s servers went on vacation.

    Tell me again about the future of cloud computing. Thanks, I’ll pass. Send me a program disk that I can put on a computer that is not connected to the internet.

  29. Barry B July 6, 2011 5:35 pm #

    Owen,

    I don’t disagree with you.

    I’ve sold every technology that was leading edge since 1970…up to and including the present time where I’m currently selling a platform for “Data Virtualization”…the next step and leading edge in cloud computing.

    The attractiveness of cloud technology is that it has morphed computing and IT into a utility type of service…that is you pay for what you use and don’t have to have the headaches associated with managing the infrastructure on premises.

    Computing is now a service that is purchased on an as needed basis. Someone else manages the computers/servers, storage, network, and the actual delivery of the software itself. This is called “Software As A Service” or SaaS…and is the current direction in application delivery…note the success of SalesForce.COM (CRM)…the leader in SaaS.

    All of the associated services are now outsourced, much as in the outsourcing of programming jobs to the third world. There are tremendous cost savings associated with this type of computing paradigm shift. Also, the IT Director doesn’t take a hit when the services go down as he/she would have in the past.

    Unfortunately, this all comes at a cost of jobs. I’ve spent my entire adult life in this business and I WOULD NOT recommend my children going into it…the jobs are gone.

    Industry has to adapt or they will be put out of business by lower cost competitors. US technology is driving these initiatives and whether we like it or not…the world has changed.

    Sorry for the rant! I’ll step down from my soap box now. But I do agree with you.

    Best,

    Barry

  30. owenCPA July 6, 2011 7:11 pm #

    Barry,

    I think the concept of cloud computing is good. A few years ago I worked at a CPA firm where we moved our tax client information onto the tax software company’s website. It was great. Problem with the return? The open it at the same time, you can see the numbers change, or the boxes get checked, and you are done…..until the network is down, or their server is down. Then we play solitaire until it comes back up, and we hope they never get hacked.

    Between tablets, and smartphones, the cloud makes some sense. Wherever you go, you get into your software and data. Nice idea, until someone else gets into your software and data.

    I think there is ample opportunity for your children in cloud computing. One or two can find ways to break into a cloud, and the others can work on developing ways to keep them out. Since the day the first door was invented, people have maintained a competition to keep people out, and to break in. Locksmiths make money. Lock manufacturers make money. The homeowner stands in front of his door banging his head against it because he locked his keys inside, while the burglar walking by considers showing him how to use a credit card to open the locked door.

    Technology makes some jobs, or people obsolete. It also makes new opportunities for new jobs and new industry. Cablevision may disappear thanks to Netflix, but Netflix is looking to create its own programs because the networks want too much money, or won’t let them use network programs at all.

    There will always be the need for the Geek Squad, as full time staff, or as indepents. Until the geeks do not have to ask, “Is it plugged in?”, or say, “No, that little tray that pops out is NOT the coffee cup holder”, there will still be a need for the Geek Squads.

    My favorite comedian is Bill Engvall. Stupid people should wear signs. “No, LOG IN has nothing to do with trees! HEEEERE’S your sign.”

  31. Mark T. July 6, 2011 8:52 pm #

    Alan,

    Since I learned enough from you to sell ITM calls for this cycle and with the bull run we had last week some of them are way ITM and have almost no time value left. I rolled them already to August expirations since I could get almost all of my ROO. And yes I did roll up but still ITM to be on the conservative side.

    My question is that since next month is a 5 week cycle and then since I sold the calls a week or 10 days early should I adjust my timing on when to buy back under the 10 or 20 percent guidelines.

    Thanks,
    Mark Tooker

  32. Barry B July 6, 2011 10:52 pm #

    Owen,

    Owen, you may have missed my point…but we do agree on the value of cloud computing. The new paradigm gives users more capability for a lower investment and lower ongoing costs.

    As for my children…actually, my son is in IT…he is a network security and data forensics analyst. He originally he was going to be a developer. Then development jobs were outsourced overseas. He then moved into infrastructure management and disaster recovery. The cloud migration then moved his job off his company’s premises. Seeing an opportunity, he went back to school for an advanced technology degree, got the highest level professional security certifications, and moved into security. He has been able to stay up-to-date and relevant. But he is more of an exception. The sad fact is that a lot of IT people have been forced to change careers.

    Back to my original point…there has been a huge shift in computing infrastructure, software technology platforms, and manpower requirements. Today, cloud computing is the prime mover for these changes. Earlier in this decade, the movement was to “virtualization”…more efficient use of existing hardware through hardware consolidation. These savings were driven by new software technologies.

    Not only has new technology made every employee more productive but has improved technology management to such an extent that the number if IT people required to accomplish the same task has been dramatically reduced…and those tasks that are left are moving off premises more rapidly.

    My original “rant” was focused on the new ETF SKYY. I think that this will be a giant winner. I just hope options will be available…and…if they pass our screens…we can use them for covered call writing.

    Barry

  33. admin July 7, 2011 6:56 am #

    Mark (#31),

    First let me congratulate you on your stock selection and investment success this contract month. My responses:

    1- When the time value approaches zero mid-month, consider completely unwinding your position (buying back the option and selling the stock) and use the cash to establish a NEW cc position and a 2nd income stream in the SAME month with the SAME investment cash. Oftentimes this will generate an additional 1-2%.

    2- If you decide to roll out and up to an in-the-money strike, the 20% guideline would apply from the time the exit strategy is implemented through the third week of a 5-week cycle at which time the 10% guideline would kick in.

    Alan

  34. owenCPA July 7, 2011 11:40 am #

    Earnings reminder:

    Despite the much fun (and profit) I’ve been having trading options on GOOG, NFLX and AAPL in the past two months, they all are reporting earnings this month. NFLX and AAPL are scheduled for the 19th, which is fine for July options expiring on the 15th. GOOG, on the other hand, is reporting on the 14th. I will be closing my July options Monday or Tuesday.

  35. admin July 7, 2011 3:38 pm #

    RBN:

    A stock on our premium watch list for 8 weeks recently reported a solid 1st quarter earnings report. Reveues were up 42% as it has averaged positive earnings surprises of 33% over the past 4 quarters. Its balance sheet shows $172M in cash with no long-term debt. It projects a 26% growth for 2012. This stock trades at a reasonable PEG of 0.88 below the value benchmark of 1.0. Our premium report shows and industry segment rank of “A”, a beta of 1.53 and a dividend yield of 0.30.

    Technically this equity recently emerged from a multi-month period of consolidation (see red lines in the chart below) to a new all-time high (see green arrow in the chart). Click on the chart to enlarge it and use the back arrow to return to this blog.

    Alan

  36. admin July 7, 2011 6:36 pm #

    Premium members:

    This week’s 6-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site.

    For your convenience, here is the link to login to the premium site:

    https://www.thebluecollarinvestor.com/member/login.php

    Not a premium member? Check out this link:

    https://www.thebluecollarinvestor.com/membership.shtml

    Alan and the BCI team

  37. admin July 8, 2011 7:36 am #

    TPX:

    First quarter earnings reported a 28% increase in revenues, a 14% positive earnings surprise over the past 4 quarters and a bullish growth projection of 17%. The company repurchased 1.32M shares during the quarter enhancing shareholder value. Our premium watch list shows an industry segment rank of “A” and a beta of 1.47. This stock has now been on our premium watch list for 11 consecutive weeks.

    Alan

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