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The market prices of investments that have a known return do not tend to bounce around as much as the market prices of alternatives with lesser known returns. With a known return, the speculators - those fairly certain that they know something that is unknown to others - are removed from the market.

Preferred stocks, for example, tend to show less market price volatility than common stocks for this very reason. In almost all cases, preferred stocks pay a dividend of a known amount on a known schedule.

As intuitively obvious as this seems, we rarely have an opportunity to directly measure it, but one such opportunity presented itself during November.

In the aftermath of the November 6 elections, the S&P 500 Index of common stock prices fell by 5.25% (November 15) but has gradually regained most of that loss over the subsequent weeks. By plotting the movement of preferred stock market prices over the same period, we have a rare opportunity to directly compare the volatility of preferred stocks to common stocks in response to a known event.

Post-election stock prices, preferred versus common stock

Over the last three weeks of November, the market prices of preferred stocks, as reflected by the iShares US Preferred Stock ETF (PFF), followed the same pattern. But note how much less volatile the market prices of preferred stocks were over this period. While common stock prices dropped 5.25%, preferred stock prices fell less than half of that amount (-2.08% on November 15).

Preferred Dividends Versus Common Dividends

Common stocks have shown no overall price appreciation over the last thirteen years (with a couple of spectacular exceptions during 2003 and 2009). Similarly, preferred stock prices have been flat as well but, as described above, for very different reasons [1].

Having little in the way of price appreciation to brag about brings investors back to the dividend opportunity offered by these two alternatives. And keep in mind that preferred stock shareholders are always paid first before holders of the same company's common stock, lowering the investor's risk.

Common stocks have paid an average annual dividend of about 2% while preferred stocks are currently paying about 6% (about 1% below their 7% long-term average).

Real Estate Investment Trusts (REITs) tend to be a bit more generous. Take a look at this chart comparing the dividend yields currently offered by REIT preferred stock versus the same company's common stock dividend yield. Each diamond represents a specific REIT company.

REIT Preferred versus Common Stock Yields

There are currently 42 high quality [2] preferred stocks trading on U.S. stock exchanges issued by 14 REITs. In 11 out of these 14 cases, the company's preferred stocks are offering an annual dividend yield that outpaces the same company's common stock yield (as of November 30, 2012).

The three exceptions that you see above the Equal Yield Line are PS Business Parks (PSB), Public Storage (PSA) and Hospitality Properties (HPT). In each of these three cases, the current yield being offered by these companies' common stock dividend exceeds that available from the average dividend yield of their preferred stock offerings.

Them's Fightin' Words

Given the choice between two alternative investments - one with little price volatility, zero value appreciation but a current average 6% annual dividend payout versus a second alternative that has substantial price volatility, zero overall value appreciation over the last thirteen years and an average 2% annual dividend payout that you only receive after those who pick the first alternative are paid in full, which would you choose?

As evidenced by the millions of common shares that trade every day, there are certainly reasons that one would invest in common stocks rather than preferreds, but overall price appreciation performance, dividend payout and risk reduction do not appear to be among them.

Footnotes:

1. In addition to having a known return, another reason that preferred stocks show less price volatility is due to their 'par' value (usually $25 per share). This is the amount that a shareholder will receive in the event that the issuing company calls the security (buys the shares back from shareholders). Since a preferred stock's par value is published in the security's prospectus and is therefore known to investors, preferred stock prices generally do not venture too far away, especially if the market believes that a call is likely.

2. "High quality" preferred stocks are those that meet the ten preferred stock selection criteria itemized in my book, Preferred Stock Investing (such as having cumulative dividends and investment grade ratings).

Source: Price Stability Of Preferred Stocks On Display During November

Additional disclosure: Securities identified within this article are for illustration purposes only and are not to be taken are recommendations.