Ask TheStreet: Preferred Stock

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How do I evaluate preferred stocks? For instance, Goldman Sachs has four different preferred issues; how do I find out how they're different? -- B.A.

Simon Constable: Before we get to specifics about Goldman Sachs(GS Quote) and its four preferred classes, let's get into the basics of preferred stocks.

This form of stock is a hybrid security that is a little like debt and a little like equity. Like common stock (which is what is most often bought and sold on the market), preferred stock can carry voting rights in the company, but like bonds, it has fixed cash payments that are made on a predetermined schedule.

That combination makes them very attractive to venture capitalists looking to invest in start-up companies, explains Michael Schill, professor of finance at the University of Virginia's Darden Graduate School of Business Administration. That's because preferred stockholders typically get promised payments yet with greater control on firm policy than that maintained by bond holders. Bond holders often find their voices ignored, he says.

Preferred share dividends are typically higher than the interest coupons on a company's bonds. And for that reason they often trade like bonds, moving down in price when interest rates go up (and up when rates fall). Those high "coupons," however, can give preferred stock higher equity-type returns overall.

That bigger return is in part compensation for the additional risk taken on by the investor, because in the event of bankruptcy, preferred holders only get paid if there is any money left after bond obligations are settled.

Like "souped-up" sports cars, preferred shares all have basic similarities, but most are custom built. Even those issued by the same company can have different features. For that reason investors need to ask some important questions before buying.

The key questions are what is the maturity date, what is the so-called "yield-to-call," and how good is the credit quality, says Rob Brown, chief investment officer at Genworth(GNW Quote), an insurance and financial services company.