WALL STREET, CALIFORNIA : Weighing Preferreds Is Tricky Business

Despite their name, preferred stocks aren’t always preferable to other income-oriented investments.

Preferreds are tricky to analyze, and they’re such a niche investment that there’s scant information about them on the Internet.

Indeed, Preferredstock.com is the Web site for a men’s cologne.

When investigating a preferred stock, investors must weigh factors such as the stock’s maturity date, its “callability” and its credit rating.

And to assess a preferred stock’s true return, investors must grasp the difference between “current yield” and “yield to call.”

Consider a preferred stock issued last month by Edison International, the Rosemead-based parent of Southern California Edison.

The stock pays an annual dividend of $1.97 a share. With the share price at $24.50 now, the current dividend yield tops 8%.

With the yield on the 30-year U.S. Treasury bond now around 6%, a yield of almost 8% on a high-quality corporate security would seem attractive.

But Stephen Isaacson, a preferred-stock specialist at institutional brokerage B.C. Ziegler & Co. in West Bend, Wis., says investors looking at the Edison issue should start by comparing it to a 10-year bond Edison recently issued.

That bond’s annualized yield is 7.7%. Is the bond more or less attractive than the preferred stock? There are several issues to consider:

* The preferred shares can be “called” in July 2004. If market interest rates fall between now and then, Edison can force preferred holders to sell the shares back to the firm at that point, at $25 each.

Many preferred stocks can be called within five years of issuance. It’s crucial to know the call features before buying.

Edison’s 10-year note, by contrast, can’t be called, so investors can lock in that yield until 2009.

* Though the Edison preferred is scheduled to mature in 2029, the company has the right to push back that date by 19 years, meaning it could mature as late as 2048.

“That’s forever,” Isaacson said.

Why does that matter? Because the longer the period until maturity, the greater the risk the firm could run into financial problems.

* The Edison preferred gives the company the right to postpone dividends for up to five years. That’s a “60-month holiday” in industry parlance, said Kathleen McNamara, a preferred-stock specialist at Salomon Smith Barney.

If Edison were to postpone, the preferred holders would either have to stick it out until payments resume, or sell their shares at a depressed market price.

At the end of the five-year period, Edison would owe back dividend payments to investors. But to add insult to injury, shareholders would be liable for taxes on those payments in the interim--just as if they’d received them all along, said Mario DeRose, a fixed-income specialist at brokerage Edward Jones.

If the company couldn’t resume payments after five years, preferred holders could only then take action against the company, such as working to seize assets.

By contrast, if the company missed a bond payment, bondholders could take action immediately.

* The company’s right to defer dividends means the preferred has a lower credit rating than the Edison bond. The bond is rated A- by Standard & Poor’s, but the preferred is a notch lower at BBB+.

Historically, very few preferred issuers have deferred payments or pushed back their maturity dates. Still, Isaacson says, a reasonable analysis would question whether the slightly higher yield on the Edison preferred is enough to warrant the additional risk that problems could develop.

“If you’re going from a Ford to a Mercedes, that’s one thing,” Isaacson said. “But if you’re going from a Ford to a Mercury, that’s another thing, and here you’re going to a Mercury but paying a Mercedes price” in the preferred relative to the bond, he said.

Finally, with all preferreds, investors must know their true return.

Your “current yield” is the annual dividend divided by the current share price. But that may not be your true return. Because most preferreds are redeemable at their issue price (usually $25), you could have a net principal loss or gain if you hold until the shares are redeemed.

The “yield to call” calculation accounts for the potential gain or loss on your shares.

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Walter Hamilton can be reached by e-mail at walter.hamilton@latimes.com.

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Some Preferred Preferreds

Fixed-income strategist Mario DeRose at brokerage Edward Jones in St. Louis recommends the following three preferred stocks. Each is rated at least “A-” by Standard & Poor’s for credit quality. The “call date” is when the issuer can repurchase the stocks from investors at $25 a share. “Current yield” is the annual dividend divided by the current stock price. The “yield to call” adjusts the current yield for the net gain or loss in principal if you buy at the current price and the shares are redeemed at $25 on the call date.

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Annual Monday Call Current Yield to Issuer dividend close date yield call Georgia Power $1.90 $24.50 01/02 7.76% 9.23% Citigroup 1.75 23.06 11/03 7.59 9.56 Duke Energy 2.09 25.91 08/04 8.08 7.61

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Note: All three trade on New York Stock Exchange.

Source: Bloomberg News