Income that isn't eroded by inflation — Understanding Taiwan's preferred stock investments

Why Focus on Preferred Stocks?

In an era of alternating high inflation and low interest rates, traditional investors face a dilemma: bank deposits can’t keep pace with rising prices, bond investments have high thresholds, and common stocks are highly volatile and unpredictable. At this time, preferred stocks, which sit between bonds and stocks, are gaining attention. Can they become the game-changer for balancing risk and return?

What Are Preferred Stocks? How Do They Differ from Common Stocks?

First, two concepts need to be distinguished. Common stocks represent ownership shares in a company, allowing shareholders to participate in decision-making (voting rights), but dividends depend on the company’s profitability—generous during good times, possibly zero during downturns.

Preferred stocks follow different rules. When issuing preferred stocks, companies announce the annual dividend amount or rate in advance, meaning that regardless of business performance, preferred shareholders have priority in profit distribution. When earnings are limited, dividends to preferred shareholders are paid first, with remaining profits going to common shareholders.

However, note that if the company incurs losses, preferred shareholders may also receive no dividends. But if investors buy “cumulative preferred stocks,” unpaid dividends accumulate year by year and are paid out once the company recovers profitability.

Key Features of Preferred Stocks

In simple terms, preferred stocks combine characteristics of stocks and bonds—offering stable cash flow like bonds, yet with liquidity and tradability like stocks.

What Are the Variants of Preferred Stocks?

Depending on contractual design, preferred stocks can be divided into several types:

Perpetual vs. Term Perpetual preferred stocks have no maturity or redemption date, allowing investors to receive dividends indefinitely. In contrast, some preferred stocks can be redeemed by the company after a certain number of years at issuance price, which may cut off long-term cash flow plans.

Cumulative vs. Non-Cumulative Cumulative preferred stocks allow the company to suspend dividends in certain years and pay them later; non-cumulative preferred stocks do not have this right, and unpaid dividends are forever forfeited.

Participation Rights Some preferred stocks can share in excess dividends alongside fixed dividends (e.g., in prosperous years); most do not have this feature.

Convertibility A minority of preferred stocks can be converted into common stocks under certain conditions, with prices more closely tracking the underlying common stock.

Current Market and Cases in Taiwan

Taiwan’s preferred stock market is much smaller than its common stock market, limiting investor choices. According to findbillion platform data, currently listed preferred stocks include:

• Shin Kong Financial Holdings A Preferred (2888A) and B Preferred (2888B): Both with yields over 5%. Although Shin Kong Financial’s stock price performance is poor, its business fundamentals are stable, with no short-term losses expected, making dividend risk relatively manageable.
• Taiwan Cement Preferred Stock: Issued in 2018, face value of NT$50, fixed annual interest of NT$1.75, yielding 3.5%.

Most of these stocks are issued by large financial or industrial groups, with relatively low risk.

Two Investment Paths for Preferred Stocks

Path 1: Select Individual Stocks Suitable for investors with research time and ability. Focus on two details: whether the preferred stock can be redeemed early (affecting expected holding period), and whether it is convertible into common stock (affected by common stock price fluctuations).

Path 2: Preferred Stock ETFs For busy professionals or market newcomers, investing indirectly through preferred stock-themed funds (e.g., Yuanta Taiwan Preferred High Dividend 20 Index ETF〈020008〉) is more convenient. ETFs automatically diversify risk, and investors don’t need to analyze redemption or conversion terms for each stock.

Pros and Cons of Investing in Preferred Stocks

Advantages

• Stable Dividends: Fixed dividend rates enable precise financial planning, suitable for retirees or conservative investors.
• Price Stability: Clear dividend policies usually result in less price fluctuation compared to common stocks, favored by institutional investors.
• Credit Backing: Many preferred stocks are issued by financially solid large enterprises, with lower bankruptcy risk.

Disadvantages

• Limited Growth: During explosive company growth, preferred stockholders cannot share excess profits.
• Price Ceiling: Even with good prospects, preferred stock prices are often anchored to yields, limiting upside potential.
• Redemption Risk: If the issuer redeems preferred stocks early, long-term plans may be disrupted, and finding equivalent alternatives later can be difficult.

Who Are Suitable for Preferred Stock Investment?

Ideal Investors

• Retirees or those nearing retirement seeking stable passive income.
• Investors with low risk tolerance prioritizing capital preservation.
• Those seeking diversified asset allocation to reduce overall portfolio volatility.

Less Suitable

• Young investors with long investment horizons aiming for higher growth.
• Active traders, as preferred stocks often have lower liquidity and smaller price swings, making short-term trading less advantageous.

Conclusion

The essence of preferred stocks is “stable cash flow” and “low volatility”, making them defensive assets in inflationary times. They won’t deliver the high returns of common stocks but can provide relatively certain interest income amid market uncertainties.

Before investing, clarify three questions: Is the company’s fundamentals stable (affecting dividend certainty)? Is the preferred stock redeemable (affecting expected duration)? Does your risk appetite match (don’t expect high growth). Doing thorough research on preferred stocks or simply diversifying via ETFs can help assets grow steadily during inflationary periods.