Almost exactly one-year ago, on June 5, I suggested that you check out four preferred stocks that I thought worth a look. Had you bought all four, as of last Wednesday, your portfolio would have averaged an 11 percent return compared to the S&P 500's two percent return over the same period. Besides for the higher return, your ride would have been a lot smoother. None of the four preferreds recorded losses and the individual gains ranged between eight percent and 17 percent.

Now that I have your attention, here's what you need to know about preferred stocks.

Although they trade like stocks, preferreds represent debt, not ownership. Companies issue preferred stocks for the same reason that they sell bonds -- to raise cash. Investors buy preferreds for the steady income. Many are paying dividends equating to five to eight percent yields [annual dividend income divided by your cost], and some even higher. Also, some preferreds also offer modest appreciation potential.

Nut and Bolts

When a firm sells preferreds, it sets the issue price, typically $25 per share, and the annual dividend, which is usually paid quarterly [four times per year]. The annual dividend divided by the issue price is termed the "coupon rate." For instance, the coupon rate would be 10 percent if a company pays $2.50 per year in dividends on preferreds initially sold for $25 per share.

After the initial sale, the preferred shares trade the same as regular stocks,

with their share prices reflecting the balance of supply versus demand for the shares. Major factors affecting preferred share prices include the coupon rate and the perceived safety of the expected dividend stream.

Dividend safety is an issue because, unlike bonds, companies can suspend their preferred dividend payments without filing for bankruptcy. Thus, preferreds issued by firms with shaky balance sheets or in sectors perceived as risky will trade below their issue prices.

When the share price changes, the yield to new money, termed the "market yield," changes as well. For instance, if the price of the preferred mentioned previously paying $2.50 per year fell to $24, the market yield would rise to 10.4 percent [$2.50 divided by $24.00].

Most issuers reserve the right to redeem [call] their preferreds at the "call price," which is usually the same as the issue price, any time after the "call date," which is typically five years after the issue date. Firms don't have to call their preferreds on the call date and many preferreds are not called for years after their call dates.

Current Prices

Currently, many $25 preferreds with coupon rates of six percent or more and backed by firms with strong balance sheets are trading in the $26 to $28 range.

Conversely, preferreds issued by companies in out-of-favor sectors such as large banks and real estate investment trusts are mostly trading from five to 20 percent below their call [and issue] prices. Consequently, their market yields [return on new purchases] are five to 20 percent above their coupon rates. Here's what's interesting about these preferreds.

Assuming that the issuers continue to pay the required dividends on schedule, the preferreds will eventually trade back up to their call prices, more or less. If that happens, investors who purchased when the preferreds were out of favor gain two ways: they earn a higher yield and enjoy modest capital appreciation as well. That was the case for two of the four stocks in last year's list. Thanks to the combination of higher yield and around five percent capital appreciation, one returned 17 percent for the year and the other gained 12 percent.

Finding Preferreds

Quantum Online [www.quantumonline.com] is the "go to site" for finding preferred candidates. You can use Quantum's screener to find preferreds meeting your requirements [Select Income Tables and then Income Securities Screening]. From the screener, click on each ticker symbol to see Quantum's in-depth description of that preferred.

Evaluating Preferreds

Unlike common stocks, preferred ticker symbols are not standardized and vary from site to site and broker to broker. However, Microsoft Money [money.msn.com] and TDAmeritrade [www.tdameritrade.com] use the same symbols as Quantum. You don't have to be a TDAmeritrade customer to see its basic information on preferreds [When you're ready to buy, use your broker's symbol lookup function to find the preferred].

Use TDAmeritrade or Microsoft Money to check the current trading price and recent daily trading volume for your candidates. Avoid preferreds trading less than 5,000 shares daily.

When evaluating preferreds, confirm that the issuing company has the ability to pay its preferred dividends on schedule. While I don't have room to cover evaluating a firm's fiscal fitness here, as a rule of thumb, sticking with preferreds issued by firms with common stocks trading above $15 per share should keep you out of trouble.

When evaluating candidates trading above their call prices, avoid those trading 10 percent or more above their call prices, and/or those with calls dates sooner than three years out.

For more on evaluating preferreds, check the Preferred Stocks section of my Dividend Detective site [www.dividenddetective.com].

Here is my new list of four preferreds worth considering now.

Goldman Sachs 6.125 percent Notes [ticker GSF]: call price $25.00, recent price $25.13. Market yield 6.1 percent. Call date 11/1/15.

Aspen Insurance Holdings7.25 percent [AHL-B]: call price $25.00, recent price $25.23. Market yield 7.2 percent, Call date 7/1/17

Lexington Realty Trust 6.50 percent Series C [LXP-C]: call price $50.00, recent price $43.40. Market yield 7.5 percent. Call date anytime [that's OK, since if called, capital appreciation would be 15 percent].

KKR Financial Holdings 8.375 percent Senior Notes [KFH]: call price $25.00, recent price $26.69. Market yield 7.8 percent, Call date 11/15/16.

Do your due diligence. Preferreds have no value if the issuing company doesn't have the cash to pay the dividends. As is always the case in the market, the more you know about your stocks, the better your results.

Harry Domash of Aptos publishes the Winning Investing and the Dividend Detective websites. Contact him at www.winninginvesting.com or Santa Cruz Sentinel, 1800 Green Hills Road, Suite 210, Scotts Valley, CA 95066.