You Should Prefer This Dividend Play

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Dividend stocks are sweeping the nation as investors try to squeeze their portfolios for as much income as they can get. Knowing how important it is for those investors to meet their income needs, the companies that create exchange-traded funds have focused on income-generating ETFs that deliver the goods to cash-strapped shareholders.

One of the most recent income-oriented ETFs looks in a new place for great dividends. But while the ETF may break new ground, the concept behind it has a well-established history.

The basics of preferred stock
The iShares S&P International Preferred Stock Index ETF invests in preferred shares of countries from developed foreign markets. By doing so, the ETF offers many investors two types of diversification that they might otherwise not get in a single package.

You're probably already familiar with how international investments can help diversify your stock exposure. Even though an increasingly global economy has led to greater correlations among returns on markets around the world, local events can still have a greater impact on one area than another, making it valuable to avoid having all your eggs in one basket.

But fewer investors are familiar with preferred stock. Preferreds get their name from the fact that when a company liquidates, preferred shares have the first claim to any assets left over after bondholders get paid. Only once preferred shareholders receive the full amount of the preference do common stock investors get a dime. In addition, preferreds tend to have more lucrative dividend yields than their common counterparts, and again, preferred shareholders typically have to receive their full dividend before common shareholders are entitled to any dividend payout.

The net result of those characteristics is that preferred shareholders give up the potential upside of common stock in exchange for greater security and the ability to lock in what's usually a higher dividend yield. In a market environment in which even common shareholders don't always see their stock prices rise, the trade-off involved in buying preferreds may seem like a smart bet right now.

What you get
The appealing thing about the new iShares ETF is the unique exposure it gives. Domestic preferreds often center around financial institutions, which may make investors nervous given their current fragility. But in contrast, the iShares ETF holds shares of companies like Canadian pipeline giant TransCanada (NYS: TRP) , Shaw Communications (NYS: SJR) , and Aviva (NYS: AV) .

Moreover, even the banks and other financial companies the iShares ETF owns shares of tend to be in safer parts of the industry than the too-big-to-fail institutions you're all too familiar with. Canadian banksToronto Dominion (NYS: TD) , Royal Bank of Canada (NYS: RY) , and Bank of Montreal (NYS: BMO) gained solid reputations during the financial crisis, largely because the Canadian mortgage market never cratered to nearly the extent that U.S. banks saw. Similarly, Brookfield Asset Management (NYS: BAM) emerged from the crisis fairly well compared to some of its peers, taking advantage of the plunge to pick up some bargain properties on the cheap.

Geographically, Canadian companies dominate the portfolio, with stocks from the U.K., New Zealand, and Sweden making up the lion's share of the remainder. Conspicuous in their absence are any companies from the main part of continental Europe -- probably to the satisfaction of any prospective shareholders.

What's your preference?
The iShares international preferred ETF isn't a must-own fund for every investor. In general, if you're looking for ways to earn income from international investments, there are plenty of alternatives that produce dividend income from common stocks. And for safer plays, international bond funds and ETFs have become increasingly popular as well.

But preferred stocks share characteristics of both bonds and stocks in a way that's hard to replicate elsewhere. If you like the idea of boosting your income even at the cost of upside appreciation potential, then preferred shares and the ETFs that own them are worth a closer look.

Like the potato chip jingle goes, no investor can buy just one ETF. Take a look at The Motley Fool's free special report on ETFs and get some more great ETF ideas for your portfolio.

At the time this article was published Fool contributor Dan Caplinger prefers dividends. You can follow him on Twitter here. He doesn't own shares of the stocks mentioned in this article. Motley Fool newsletter services have recommended buying shares of TransCanada and Brookfield Asset Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy always gives you preferred treatment.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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