Chasing Alphabet's 6.25% Dividend Yield? Read the Fine Print First.

Alphabet (NASDAQ: GOOGL) (NASDAQ: GOOG) historically has had no shortage of growth opportunities to direct its capital toward. That's why it never paid a dividend in the past, as management felt the cash was better suited to reinvest in the business. This philosophy changed in June 2024, when the company paid its first quarterly dividend of $0.20 per share. That payout is now $0.22 per quarter. But the low dividend yield of 0.25% isn't enough to compel income investors to buy this Magnificent Seven stock.

The situation looks a bit different now. Alphabet is investing so much to expand its artificial intelligence (AI) infrastructure that it has now tapped equity markets to raise fresh capital. As part of a nearly $85 billion raise, the company issued $16.75 billion of convertible preferred stock (GOOGM is the Class A equivalent, and GOOGN is the Class C equivalent). It offered a hefty 6.25% dividend yield at issuance.

That seems like a good deal, especially since the preferred stock comes from one of the most dominant tech companies. Before you rush to buy, read the fine print first.

Image source: The Motley Fool.

Sitting between bondholders and common shareholders

Preferred equity is a hybrid security that mimics both bonds, because they have a fixed dividend, and equities, since they represent ownership. And on the capital structure, it sits between bondholders and common shareholders. If a company goes bankrupt and has to liquidate assets, preferred holders get paid out before common equity holders.

These investment products are catered to a specific type of market participant. Investors who want to earn yield and limit downside will find preferred equities attractive.

Bullish investors should pass on this

Alphabet's preferred stock isn't perpetual. Instead, it will convert to common shares on May 15, 2029. So, the 6.25% dividend yield will be active for only about three years. After that, investors can expect to receive the common stock's low 0.25% yield.

The conversion details can be confusing for average investors. Your decision to buy the preferred stock comes down to your forecast of where Alphabet's common shares will be in the future. If the stock price doubles in five years, which is a reasonable view given the company's impressive profit growth relative to its current valuation, then it makes sense to keep things simple and own the common shares.

On the other hand, if you believe Alphabet's common shares will be flat or decline over the next five years, then owning the preferred shares is interesting. There's income to be made.

For long-term investors, however, it's best to pass on this financial instrument. While the dividend yield draws a lot of attention, the fine print presents a more complex situation.

Neil Patel has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet. The Motley Fool has a disclosure policy.