WHAT IS CONVERTIBLE PREFERRED STOCK?
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To some investors, convertible preferred stock
offers the best of both worlds. Because this stock can be converted
to common stock if it rises to a specific price, it offers
investors the benefit of owning both types. Like with a convertible
car, they can leave the top up (stay with preferred stock) if the
weather is cloudy—or put the top down (convert to common
stock) if the weather is sunny and the company's common stock price
is rising. Though it is fairly rare, some investors look for the
double features of convertible preferred stock.
For instance, you may own a convertible preferred
stock that you purchased for $22 per share. In this case, you could
convert your preferred stock to common stock when the price of the
common stock reaches, say, $26 per share. At that point, you may
want to convert the stock and sell the common stock for a
Convertibles offer higher income than common stock
yet can gain more in value than regular preferred stock or bonds.
If the price of the common stock drops instead of rising, the
convertibles will retain their value better. This hybrid offers the
prospect of higher returns than regular preferred stock, in
exchange for a somewhat higher level of risk. Yet the risk is still
less than it would be for common stock from the same company.
Investors sometimes buy convertibles if a company's stock has a
higher risk than they are comfortable with.
Critics may ask, What is the point of a convertible?
Any investor can receive benefits similar to those of convertibles
just by investing in different asset categories. The attraction of
owning two different classes of stock in one still appeals to a
number of investors, however.
Convertible preferred stocks can enhance the
flexibility of an investor's portfolio, but they are not the only
way to do so.