Bond-Like Characteristics
Because preferreds are largely yield plays, they tend to move like bonds. Their prices are affected by long-term interest rates, spreads over Treasuries and the credit quality of the industry and issuer. Profit fluctuations do not affect preferred share prices of healthy companies.

Preferreds come with call dates.  This is when the issuer has the right to buy back shares-typically starting five years after issuance.  The fact that a preferred can be called can keep prices of healthy companies from moving too far above or below par.  Preferreds are called when a series is issued with a high coupon and rates have subsequently fallen, enabling the company to refinance at a substantially cheaper cost.

Mergers can trigger special opportunities by instantly altering risk.  Before the private equity firm Apax Partners bought out Tommy Hilfiger, for example, the retailer was struggling and its preferreds were trading well below their $25 par price-the price at which the preferred was issued and at which it can be called.  Paying a 9% coupon, these preferreds started to recover upon announcement of the deal and moved quickly toward par.  The reason: Apax is a highly regarded firm with much cheaper access to capital.  Retiring these preferreds was an instant way to cut costs, and the private equity firm did so at the first opportunity.
Fear and uncertainty can also drive preferred prices.

For example, an extraordinary buying opportunity was created during the height of the credit crisis. "For the first time since they became a major source of capital financing, preferreds got pummeled indiscriminately," says Greg Phelps, senior portfolio manager of more than $4 billion of John Hancock preferred funds.  Instead of moving in response to interest rates, credit issues and yield spreads, many venerable preferreds tracked common shares, as fears of insolvency, reorganization or nationalization brought their values to unprecedented lows.

Deutsche Bank saw its $25 par trust preferred, with a coupon paying 6.37%, collapse from $20 in the middle of 2008 to below $5 in early March 2009, yielding nearly 32%. Deutsche Bank preferreds have since recovered, trading in January at about $22.
The return of stability to the credit market and recovery of preferred shares has likely brought an end to the recent rally. Robert Ettinger, president of Flaherty & Crumrine, which manages $4.1 billion in preferred stocks, says investors should expect future returns to more closely reflect current yields, in the mid-to-high single digits.

Senvest's Gonick, however, sees potential in certain shares whose dividends have been suspended.  Despite having been rescued by the British government, which now owns 85% of the institution, the Royal Bank of Scotland continued to pay dividends on its preferreds until the European Commission ruled that, as of April 2010, it had to suspend payment on most of its preferreds for two years.

Gonick believes that without the ruling, RBS would've continued paying preferred dividends to sustain its standing in the capital markets.  He believes that once the suspension period is over, RBS will reinstate the dividends. So he started buying these securities early last year when they were trading around $10, thinking of them as zero-coupon bonds. In mid-January 2011, they were trading above $17. If one presumes an 8.6% yield, which the performing RBS preferreds are currently paying, then the stock could return to the low $20s.

Buying Preferreds
More than 1,000 preferred stocks trade on U.S. stock exchanges, primarily on the New York Stock Exchange.  There are several factors to consider before investing in them.  If you're looking for secure income and the least volatile shares, experts recommend sticking with the highest-rated companies. Banking firm HSBC has a $50 par preferred Series Z that's currently yielding more than 6% and paying dividends that are taxed at 15%.  It is cumulative, which means if the dividend is ever suspended, the bank cannot start paying dividends on its common shares before it makes up every missed dividend on this preferred.  Further, this preferred offers a dividend-received deduction (DRD), which enables qualified corporations to deduct 70% of the dividend.  Toward the end of January, that meant the pretax equivalent yield for such corporations was 8.36% for this "A-" rated security. Any preferred can decline in value at any time.  But if one assumes interest rates and credit quality will remain fairly stable this year, these features can provide the HSBC issue with strong price support over at least the short term, making it an attractive alternative to nil-paying money markets. 

REIT preferreds are also a good source of preferred income because the rally in their common shares has brought down their average dividend yields, Phelps says.

Insurance companies and brokerages have been significant issuers of preferreds, whose current yields are above 7%.
Investment-grade Dutch insurer Aegon has a preferred, for example, that was paying 7.7% in late January.