What is Dividend Enhanced Convertible Stock (DECS)?

This is a type of automatically convertible security that comes in the form of preferred stock shares, which function basically like bonds, that experience a mandatory conversion to common stock at some point.

The dividend enhancement is a higher yield payout than other share classes are offered, to compensate the investor for the lack of control he or she has, since the shares will be converted at a predetermined time by the company. Mandatory convertible shares will offer a higher yield than their counterparts, but it will only last as long as the issuing company has determined.

The investor who purchases DECS gets preferred shares with high yield but has limited upside potential. The conversion usually comes at a predetermined fixed rate, and the conversion ratio actually starts to decrease once the price of the underlying shares reaches a certain point. Up until that point the conversion ratio is 1:1, and the DECS shares may be issued at the same market price as the underlying stock.

The investor trades the upside potential in the short term for the guaranteed, high-yield dividend. Because the ultimate market value of the DECS is tied to the common shares, it is still sensitive to price movements of the common stock, and its value can decline significantly depending on the value of the underlying.

Preferred Equity Redeemable Cumulative (PERC) shares are similar, but they are redeemed for cash instead of converted, but they too, are mandatory redemptions. These also fall under the category of structured convertibles.