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Preferred Stocks For High Yields Plus Capital Gains
Back in July, before the credit meltdown hit in full force, I suggested
that income-oriented investors consider preferred stocks as an
alternative to money market accounts and bank CDs.
Banks, insurance companies, real estate investment trusts (REITs),
utilities, and others sell preferred shares, instead of bonds, to raise
cash. In normal times, preferreds don’t have much price appreciation
potential. Instead, investors buy them for the steady dividends, which
typically equate to 4% to
6% yields.
A lot as happened since July. For starters, the U.S. government, in
effect, took over mortgage agencies Fannie Mae and Freddie Mac and
stopped paying both common and preferred stock dividends.
The preferred payout cancellation, an unexpected and controversial move,
pressured all preferred share prices. Then things got worse. Fears that
global credit markets might collapse sunk most stocks, including
preferreds.
Thanks to the massive intervention by governments around the world, the
credit markets have stabilized. Although we still face a potentially
serious economic recession, most large U.S. banks are no longer in
danger of failing. Similarly, the survival of REITs and utilities with
solid balance sheets is no longer in question.
The biggest risk to owning preferreds is that the issuing company either
fails entirely, or can’t come up with the cash to pay the dividends.
Given the recent government actions, assuming that you pick strong
companies, that is not as much of an issue as it was a few weeks ago.
Right Time
Preferreds are especially worth a look now for two reasons. For starters,
the dividend yields to new buyers are unusually high because their share
prices are down (yield is expected annual dividends divided by current
share price). Currently, yields range from 8.5%
to 11% for preferreds issued by Bank of America,
Citigroup, and Wells Fargo. All three have been supported in various ways
by the government and are unlikely to fail.
Price appreciation is another reason to consider preferreds now. Most
preferreds initially sell for $25. In normal times, most trade at, or
slightly above that price. Now, many are trading at significant discounts,
opening the door to potential price appreciation. For example, the last
time I looked, Bank of America Series I preferreds were changing hands at
around $19. Thus in addition to its current 8.7% dividend yield, you could
enjoy a 30% or so capital gain should the shares return to their normal
trading range.
Basics
Here are some things that you need to know about preferreds. Quantum
Online (www.quantumonline.com),
a free site, is the best place to do your initial research. MSN Money (moneycentral.msn.com)
is the best site to see current quotes, trading volumes, and price charts.
Most preferred shares are “callable,” meaning that the issuer has the
right to call (redeem) them at the “call price,” usually the original
issue price, after a specified date (call date). The issuer is not
obligated to redeem the shares at the call date. Currently, with most
trading well below their call prices, preferreds are unlikely to be
called.
Bond rating agencies such as Moody’s and Standard & Poor's rate most
preferreds using a combination of letters, numbers, and plus or minus
signs such as AAA, BA1 or B-. The details vary between agencies, but any
rating starting with A, and three letter ratings starting with B, signal
investment quality. Given current conditions, it’s best to avoid below
investment grade preferreds. Similarly, avoid unrated stocks unless you
have a good handle on the issuing firm’s financial strength.
The dividends from some preferreds are subject to the maximum 15% dividend
tax rate, while others are taxed as ordinary income. Quantum specifies
whether each stock is eligible for the 15% rate.
Some preferreds are lightly traded, making it difficult to move in or out
of a position at a reasonable price. You can find the three-month average
daily trading volumes on MSN Money’s Company Report. Avoid stocks trading
less than 10,000 shares daily.
Finding Preferreds
On Quantum Online’s
home page,
select
All Preferred Stocks from the Income Tables
dropdown menu to see the complete list, or use the ‘Income
Securities Screening Form,’
also accessed from the ‘Income Tables’ dropdown
menu to narrow your list.
Quantum doesn’t list the current trading price or dividend yield. Instead,
get the price on
MSN Money and calculate the yield (annual dividend divided by price).
Keep in mind that the higher the yield, the riskier the stock.
Here are some that I found of interest. Use the ticker symbol to research
each one on Quantum. The potential price appreciation is the difference
between the current price and the issue price.
• Bank of America Series D (ticker
BAC-D) current yield 9.1%, potential price appreciation 47%. The
government views BAC as too big to fail and thus, is probably a safe bet.
• Citigroup XV (C-U) 10.9%, 67%.
Also ‘too big to fail, but as the higher yield hints, riskier than BAC.
• Consolidated Edison Co. of NY
(ED-A) 6.2%, 24%. Consolidated is a utility serving New York City and
surrounding areas. These shares were originally issued at $100.
• Sovereign Bancorp Series C (SOV-C)
12.2%, 66%. Sovereign, considered on the ropes by many, recently agreed to
be acquired by Banco Santander, a global bank based in Spain. In my view,
the acquisition reduces the chances that Sovereign would renege on its
preferred dividends.
• Public Storage Series W (PSA-W)
9.4%, 44%. Public Storage, a REIT that operates self-storage facilities,
is rated financially solid by several analysts.
I don’t have room to cover all that you need to know about preferreds.
However, Quantum is a good resource to learn about the ins and outs about
preferred stocks in general, as well as about individual issues. The
issuer’s ticker symbol is the first part of the preferred ticker. For
instance, Consolidated Edison’s ticker symbol is ED.
Don’t even think about buying the preferreds that I mentioned before
thoroughly researching the issuing company. Also, stay abreast of current
news. In this environment, anything can happen.
published 10/26/08 |
