a guide to preferred shares

Billionaire Warren Buffett is a master at investing.

The CEO of Berkshire Hathaway is famous for buying and holding shares, without yielding to market volatility.

He is also known for his major holdings in companies, such as the $ 900 million shares he owns in Amazon.

His latest piece: a $ 10 billion investment to support Anadarko Petroleum's takeover bid by Occidental Petroleum. Berkshire Hathaway will make this investment by purchasing 100,000 Preferred Shares, which pay an annual dividend of 8%.

Preferred shares are different from common shares, the one most people are familiar with. Both are shares in a corporation, but the preferred shares generally pay a higher dividend. And this can be interesting in the current low interest rate environment.

"Think of it as a hybrid security," said Colin Gerrety, Certified Financial Planner, Client Advisor at Glassman Wealth Services.

"It has aspects similar to ordinary shares," he added. "He also has some aspects that look more like a link."

So, when is it a good idea to follow in Buffett's footsteps and invest in preferred stocks?

"If you have additional capital, a long-term horizon and consistent with your investment objective, you may want to consider it," said Marguerita Cheng, CFP and CEO. of Blue Ocean Global Wealth.

But do not limit yourself to determine if it's the right choice for you. Here are some advantages and disadvantages of investing in preferred shares.

If you want higher and more consistent dividends, investing in preferred shares can be a good addition to your portfolio.

Although he tends to pay a higher dividend rate than the bond market and common stock, he is in the middle in terms of risk, said Gerrety.

"The dividend of a preferred stock tends to be safer than a dividend on common stock but it's not as safe as investing in a traditional bond," she said. he explained.

For example, the dividend yield of Wells Fargo's common stock is 3.92% and offers several preferred stock options ranging from a 7.5% return at a yield of 5.125%. The common shares of Sempra Energy have a dividend yield of 2.96%. It also issues a mandatory convertible preferred share with a current yield of 6.19%. The convertible feature is an option for the shareholder to exchange their shares for common shares at a predetermined conversion rate.

It is also important to know that dividends are not guaranteed – they are paid out of the company's earnings, just like a common stock dividend.

However, there are several types of preferred stock, and this could affect the collection of dividends missed by the company.

Cumulative shares, such as the one Buffett has in Occidental, require the issuer to accumulate any deferred dividend payment and return it to the shareholder at a later date. In this case, the preferred shareholders have priority over the common shareholders to receive their payment arrears.

If a corporation issues non-cumulative shares, it is not required to pay the missed dividends. But because of the higher risk involved, these stocks tend to have higher returns than cumulative stocks.

The main risk associated with investing in preferred shares is that assets, like bonds, are sensitive to changes in interest rates. There is an inverse relationship between interest rates and the price not only of fixed income securities, but also of hybrid securities such as preferred shares.

"If interest rates rise, preferred shares in the market are less attractive and therefore tend to sell at lower prices," said Gerrety.

The company may also call back the preferred shares at any time, depending on the provisions of the prospectus, he said.

This means that if interest rates fall, the issuer has the right to call back the action. He can then issue new shares with a lower dividend.

Preferred shareholders do not have the right to vote, so they have no voice, for example for the election of a board of directors.

Ordinary shareholders, on the other hand, have the right to vote.

There is a tax advantage for investors in preferred shares because dividends are often taxed at qualified dividend rates.

It's less than the income from a bond, which is taxed as ordinary income, said Gerrety.

Investors should also take a closer look at the preferred share market, which is much smaller than the common stock market and is therefore not so liquid, Gerrety said. On Thursday, the size of the preferred stock market was $ 272 billion, according to the S & P Dow Jones indexes.

It also has a higher concentration of financial companies, which was hit hard by the 2008 financial crisis. Indeed, most sectors, with the exception of utilities, do not emit as much money. 39, preferred shares.

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In fact, the S & P US Preferred Equity Index holds 71% of its holdings in the sector as of April 30. While the S & P 500 Index aims to create sectoral diversity, the US preferred stock index consists of all stocks meeting its eligibility criteria – and this therefore entails a significant weighting in financial values.

"Investors can look at performance and think that it's a good way to earn a steady income and that in the absence of any shock in the system, this could be the case," she said. he declared. "But it's more risky than investing in traditional safe bonds."

"Diversification is probably the most important thing when we look at this class of assets," Cheng said.

To achieve this diversification, you can access exchange-traded funds or mutual funds, which will give you a basket of preferred shares, such as the iShares U.S. Preferred Stock ETF.

In addition, start little by little as you dive into the market and "make sure you buy products you understand," Cheng said.

Above all, do not forget to think about your broader investment portfolio, Gerrety said.

Investors "must keep in mind their overall goals." Most of the time, preference shares should not be a big part of it, "he said.

"Most investor risk and return investments can be made using conventional asset classes in stocks and bonds."