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Should Dividend Investors Buy Preferred Stock? An Expert Explains the Pros and Cons

By Jason Hall - Jan 30, 2021 at 6:02AM

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All dividend stocks are not the same. Even if they're issued by the same company.

One of the wonderful things about owning dividend stocks is that investors can get rewarded in two ways: through the dividends a company pays, and capital appreciation if the stock price goes up. But what about preferred stock? These shares often pay a higher dividend yield than a company's common stock, and can be very attractive for investors. 

However, there are some important differences between common and preferred stock that investors need to understand before investing. In a Motley Fool Live Q&A session on Oct. 29, "The Wrap" host Jason Hall explained the key differences between common and preferred shares, so that investors can make an informed decision about which is better for their portfolio. 

Transcript: 

Jason Hall: What are your thoughts on preferred stock versus equity? They're different animals.

I think, preferred stock is actually more like a bond in the mechanisms of how it works than it is a stock, because it's for a couple of things. It's ahead of common stock and the line of who gets paid and who gets repaid. If you're looking for income, if you're looking for that stable, more guaranteed source of cash, preferred stock is better. Because if a company has financial trouble, the dividend for a preferred stock has to be paid before the dividend on common stock, so there's a nice thing about it.

But the biggest thing that you lose with preferred stock is you don't get to participate in capital appreciation. The preferred stock has a pretty defined value, that's why it doesn't go up or fall sharply. It doesn't really go up because like a bond, you know what it's worth at the most. When preferred stock falls, it's because the company is in trouble. So there's risk if the preferred stock is falling because the market is making assumptions about the company's ability to continue to function financially.

In general, I tend to prefer common stock dividends. Again, because my goals; I'm in my 40s, I've got a young kid, all of my financial goals that I'm investing for are measured in decades, not in years or months. Preferred stock can be a good alternative for somebody that's looking for that more cash flow now, income now situation as an alternative to bonds that your yields might not be as well, but you still want to be able to generate some income. That's the risk and the upside with preferred stock versus equity. Think about preferred stock, again, as more like a bond than common stock.

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