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The Average Volatility of PPS

Original post by Lisa Magloff of Demand Media

The volatility of PPS depends on the health of financial industry.

The abbreviation PPS stands for participating preferred stock, a type of preferred stock. Preferred stocks are issued to private investors, not to the public. Preferred stocks may pay dividends and may be priced at a discount to publicly traded stock. One major benefit of preferred stocks is that they give holders a claim to the income and assets of a company ahead of the holders of that company's publicly traded stock, or common stock. Volatility of PPS depends largely on the volatility of the financial industry.

PPS Characteristics

Participating preferred stock is often used as a way to raise financing for start-up companies and long-term projects. Holders of PPS may be paid a dividend made up of a percentage of profit from the funded project. In this case, PPS has no secondary market and cannot be sold. Instead, the redemption value of the stock is based on future cash flow. The volatility of PPS depends entirely on the performance of the company. Preferred stocks, including PPS, are also tax exempt for companies -- that is, companies can take a tax write off on money they spend to buy PPS.

Risks

One of the major issues regarding the volatility of PPS is the risk involved if the company goes bust. In a bankruptcy, holders of PPS are paid back before the holders of publicly traded common stock, but after the bond holders. If the value of the company at dissolution is equal to the value of the company's debt, then the holders of PPS will get nothing. If a company is doing well and its value is increasing, then the holders of PPS will see some income from dividends. But they do not get capital appreciation because they cannot sell their stock on the open market. When the market is steady, the value of PPS are not very volatile. Between 2005 and 2007, the yield on preferred stocks, including PPS, fluctuated only 1 percent, between 5.7 percent and 6.7 percent.

Volatility of Financial PPS

Most preferred stocks, including PPS, are issued by financial companies. They will be more volatile at times when the financial industry is more volatile. According to the Securities Litigation and Consulting Group, in 2009 more than 82 percent of preferred stock was invested in the financial sector. Investors whose portfolio is almost entirely invested in preferred stock such as PPS will therefore be heavily reliant on the performance of the financial industry. Between 2003 and 2007, as the market expanded, preferred stocks were twice as volatile as Treasury securities and slightly more volatile than junk bonds. Between 2008 and 2010, when the market contracted, the volatility of preferred stocks increased more than the volatility of Treasury bonds and junk bonds. This is because preferred stock holders are paid off after bond holders in the case of bankruptcy, and so is more volatile in times when the market is contracting and bankruptcy is more common.

Effect of the Credit Market

Preferred stocks, including PPS, experience higher volatility than common stock or securities whenever credit becomes harder to acquire. This is because preferred stock is generally invested in financial firms, which are tied to the health of the credit market. PPS became more volatile during the economic downturn between 2008 and 2010 as banks tried to stabilize their balance sheets, tightened credit standards and became reluctant to lend. Between 2003 and 2007, when financial firms had high value and credit was plentiful, preferred stock had an average volatility that was in between the bond market and the common stock market. When the market declined in 2008, the value of financial firms declined, and preferred stock became more volatile than common stocks.

                   

References

About the Author

Since graduating with a degree in biology, Lisa Magloff has worked in many countries. Accordingly, she specializes in writing about science and travel and has written for publications as diverse as the "Snowmass Sun" and "Caterer Middle East." With numerous published books and newspaper and magazine articles to her credit, Magloff has an eclectic knowledge of everything from cooking to nuclear reactor maintenance.

Photo Credits

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