The “Special” Feature of Preferred Stocks that I like

Preferred Stock, as many investors would describe it, is a “stock” with more of characteristics of a bond rather than of a common stock. Like common stock, it is tradable in the stock market. However, unlike common stock, it does not represent a share of ownership of the company. Rather, it is a debt paper or a bond which has a fixed and “guaranteed” dividend rate and paid regularly. In case of bankruptcy, preferred shares are paid first before the common shares; however, it is second only to bonds.

Thus, like bond, one of the biggest risks of preferred shares is the inflation. This is because the dividend rate is fixed while its share price doesn’t increase so much because it does not represent ownership of the company. Its value does not appreciate with the growth of the company.  But unlike bonds, some preferred stocks have an interesting feature – the Issuer of the preferred share has an option not to redeem the shares on the agreed redemption date, and if it happens, some preferred stocks issue has a provision to   increase the dividend rate to the highest of the existing rate or a certain benchmark, and sometimes, plus additional rate points. This provision, somehow, reduce the risk due to inflation.

One such example of a preferred stock that was described is the FPHP preferred stocks in the Philippine Stock and Exchange (PSE).  As described in its prospectus, if the issuer did not redeem the stocks after 5 years of the issue, the dividend rate will be increased to the higher of 8.723% or 175bps on top of the 10 year PDS-TF (a treasury reference rate).  If the PDS-TF on the fifth year has increased to 10% due to inflation, the new dividend rate of the shares would be 11.75% (10% + 1.75%).

Filed in: Fixed Income
Local date: March, 2010

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