Performance of Preferred Stock:
Let’s compare the one-year performance of common stock and preferred stock, as of August 4, 2014. This illustration will allow the investor to differentiate between various characteristics like performance and risk.
Past performance is no guarantee of future results. Keep in mind, investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money. This is meant to be educational for the highly valued clients of Index Gurus. Since all risks and features are not stated, please work with a professional before taking action.
Preferred Stock: PG&E
Note that the 52 week range (as of August 4) is between $25.25 and $29.34. This is a fluctuation of $4.09 over the period of one year.
Common Stock: PG&E
Note that the 52 week range (as of August 4) is between $39.42 and $48.64. This is a fluctuation of $9.22 over the period of one year.
Why the difference in performance?
Preferred stocks generally will trade close to the call price, also known as liquidation preference (investopedia definition). This is a term used with fixed income investments, like bonds and even preferred stock. The call price is when the issuer will pay back or redeem the security so that it no longer has to pay the investor dividend. For preferred stock, the call price is generally $25.
The performance of the preferred stock is indicative of the objective, which is capital preservation with a focus on income. In the case of our example above, the PG&E preferred will pay dividend four times a year. The performance of the preferred is $5.13 lower than the common stock.
On the other hand, common stocks are generally for the purpose of growth and income. In our observation of performance, an investor would have made double the amount on the principal. But this comes with risk too.
Investing in fixed income is beneficial to lower risk. In the investment world, the risk is quantified as beta (wikipedia definition). The lower the beta, the lower the risk. A negative beta may indicate that the investments tends to go down when the market goes up. This is the essence of diversification and how a company like Index Gurus will diversify your portfolio.
It is important to note that a low beta for a fund does not necessarily imply that the fund has a low level of volatility. A low beta signifies only that the fund’s market-related risk is low. (Standard deviation is a measure of a fund’s absolute volatility.)
In the example above, the preferred stock has a beta of -0.15, while the common stock has a beta of 0.33. Based on historical data, we can conclude that owning both of these securities together will offer an investor diversification.
What About Bonds?
Bonds are good investments too but Index Gurus can generate the most amount of income using preferred stock.
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