Bonds aren’t the only way investors can generate income; stocks can be viable options as well. Some stocks, anyway—such as preferred stocks.

Preferred stock is a class of ownership in a corporation which generally has priority over common stockholders on earnings and assets in the event of liquidation.

Even though preferred stocks are listed as equity on a company’s balance sheet, they generally behave more like bonds than common stocks. First, some investors feel that preferred stock offers a potentially higher level of security than common stock, because if the company goes bankrupt, dividends on the company’s preferred stock are paid after the company’s debt but before dividends on the company’s common stock. (Of course, no investment is completely secure.) But preferred stock may also be a great way to generate income. That’s because preferred stock has a stated dividend which must be paid before dividends to common stockholders. And, most preferred stocks are eligible for the 15% tax rate on dividends (preferred stocks issued by real estate investment trusts, or REITS, being the notable exception).

So, if you’re looking for potentially lower volatility and higher dividends than common stocks offer for your portfolio, preferred stocks may be worth considering.

On the other hand, preferred stock offers little potential for growth of capital. An investor generally buys shares of a preferred stock with the investment goal of a relatively stable income yield rather than for the potential capital growth goal of a common stock investor. Many preferred issues trade within a dollar or two of their issue price for the long-term.

Of course, as with any investment, some preferred stocks are of a better quality than others. When buying preferred stock, as when buying any stock, it’s important to understand what the company issuing the stock does. But you also need to do a risk analysis, like you would with bonds. In other words how also likely is it that the company will be unable to pay its preferred dividends? One way to determine quality of a preferred stock is to look at the preferred stock’s rating. Like corporate bonds, preferred stocks are rated by Standard & Poor’s or Moody’s.

Where do you find preferred stock? The same place you find common stocks. Take a look at Yahoo! Finance or CNBC. On Yahoo! Finance, preferred stocks are listed by the ticker symbol of the issuing company, followed by an underscore, followed by the letter P, followed by the series letter (if there is one, and there probably is, because companies that issue preferred stocks often have more than one series, using letters of the alphabet to distinguish them). On CNBC, preferred stocks are listed by the company ticker symbol, followed by a vertical PR, followed by a letter indicating the specific issue.

As mentioned previously, preferred stocks will not provide the same long-term returns as common stock or stock mutual funds. However, they can provide an effective form of diversification even in a more aggressive portfolio, where they could perhaps be substituted for cash or guaranteed fixed-income instruments.

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