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Market Looking Too Scary? Consider Preferred Stocks

Given all that’s going on, the stock market could suffer some significant dips over the next few months. So, what to do?

You could simply sell all your holdings and put the resulting cash in a bank account paying 1% or so annual interest. But, here’s another idea.

Store your cash in in preferred stocks paying 5% to 7% dividend yields (dividend yields are similar to bank interest rates, but are not government insured). Although preferred share prices will sink with the market in a severe downdraft, if you've chosen the right preferreds, eventually they’ll recover. In the meantime, you’ll be collecting your juicy 5% to 7% dividends while you wait. 

About Preferred Stocks

Corporations issue preferreds to raise cash. While you buy or sell them the same way you trade common stocks, preferreds are more like bonds. They represent debt, not equity. While some may have appreciation potential, you buy them mostly for the steady dividends.

Minimize Risk

The main risk of holding preferreds is the issuer running short of cash to pay the specified dividends. In theory, if preferreds are labeled “cumulative,” the issuer remains on the hook for missed payouts. However, the issuer can wait five years to pay them. Consequently, priority number one is to stick with preferreds issued by firms with strong balance sheets. You can go a long way in that regard by simply checking the issuer’s common stock share price. As a rule of thumb, consider firms with common stocks trading below $10 per share as financially shaky and those trading above $50 per share to be solid players.

Most firms issue (IPO) preferreds at $25 per share, although issue prices can vary. At IPO time, the issuer specifies the dividends that it will pay, typically quarterly. The initial dividend rate (coupon rate) mostly ranges between 4% and 8%.

Since they trade on the open market, share prices vary with supply and demand. These days, most $25 preferreds eventually move up to the $27 to $28 per share trading range.

Concerning dividend yields, there are two relevant numbers; market yield and yield to call. 

Market Yield

Market yield is the return based on the current trading price. For instance, the market yield for a preferred trading at $26 per share and paying $2.00 per share annually would be 7.7%.

Yield to Call

Most preferred issuers specify a “call date” five years after the IPO. That means that the issuer has the right to redeem the shares at the call price (typically the issue price), on the call date, or anytime thereafter. So, if you pay $26 for preferreds issued at $25, you’d lose $1 per share when they’re called. The yield-to-call takes that into account. It’s the average annual return assuming that your preferreds were called at their call price on their call date. In practice that’s a worst case scenario because most issuers don’t call their preferreds on the call date. In fact, some don’t call them until years later.

You’ll come out best if you only consider preferreds with call dates at least three years out, pay no more than $2 over the call price, and if they’re trading over the call price, sell them around 12-months before the call date. 

Four Preferreds to Consider

Here are four interesting preferreds. All were issued at $25 per share.

Brighthouse Financial 6.75% Series B (BHFAO): Brighthouse offers annuity and insurance products in the U.S. Recent preferred price $27.67. Market yield 6.1%. Call date 6/25/25. Yield to call (YTC) is 5.4%.

Brunswick 6.625% Senior Unsecured Notes (BC-B): Brunswick produces a variety of consumer products including outboard boat engines and accessories. Recent preferred price $28.11. Market yield 6.0%. Call date 1/15/24. YTC is 4.0%.

CHS, Inc. 7.50% Class B Cumulative (CHSCL). CHS. Inc. is a farmer –owned cooperative. Recent preferred price $28.25 Market yield 6.6%. Call date 1/21/25. YTC 4.9%.

First Horizon National 6.6% Series C (FHN-C): First Horizon operates 490 bank branches in 11 states. Recent preferred price $26.40. Market yield 6.3%. Call date 6/1/26. YTC 5.9%.

Unlike common stocks, preferred stock ticker symbols are not standardized and vary from broker to broker. Enter the issuer’s company name and use your broker’s ticker lookup function to find the correct ticker. As always, do your due diligence, the more you know about your stocks, the better your results.

For more on evaluating preferreds, download my free Preferred Stocks Primer.  

published 9/28/20

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