Harry Domash's Winning Investing

Preferreds Offering Unexpected Returns

In normal markets, preferred stocks offer a low-risk way to earn 4% to 7% annualized dividends. But the current market is anything but normal.

Consequently, picking the right preferreds could open up the opportunity to score 10% to 20% capital gains on top of higher than expected dividend yields. 

Details in a minute. But first some things you need to know about preferreds.

Corporations issue preferreds to raise cash. Although traded the same way as common stocks, preferreds are more like bonds. Normally, you buy them for the steady dividends.

About Preferreds

When a company issues a preferred stock, it sets the annual dividend and sells the shares at a preset price, typically $25. In normal markets, $25 preferreds usually trade up to $26 to $28 per share range.

Most preferreds are callable, meaning that the issuer has the right to call (redeem) them at the call price, normally the issue price, after a specified date (call date), typically five-years after issue. Consequently, preferreds trading above $26 usually trade back down to the $25 to $26 range as the call date approaches.

But these are not normal times

Thanks to rising interest rates, many $25 preferreds are currently trading in the $20 to $23 per share range because of competition from Treasury Bonds, which are perceived as safer. But the only major risk of holding preferreds is that the preferred issuer runs short of the cash needed to pay the specified dividends. If that doesnt happen, most preferred will likely trade back up to their normal trading range if and when the market normalizes.

Identifying Low-Risk Preferreds

Fortunately, at a preferreds issuers request, bond rating agencies such as Moodys and Standard & Poors (S&P) can be hired to rate each preferreds safety. Each agencies credit ratings can be grouped into two major categories, investment grade and below investment quality, a.k.a. junk bonds.

For this column, Im using the S&Ps ratings to limit my list to investment grade preferreds. For S&P, investment quality risk ratings include: AAA, AA, BBB+, BBB and BBB-. Heres my list.

Five Recommended Preferreds  

Allstate Coupon Rate 5.10% Series H (ticker ALL-PH), 6.3% market yield, 23% potential upside, S&P rating BBB 

Bank of America 5.38% Series M (BAC-PM), 6.1% yield, 14% upside, S&P BBB-

Oaktree Capital Group 6.625% Series A (OAK-PA), 7.7% yield, 17% upside, S&P BBB

RenaissanceRe Holdings 5.75% Series F (RNR-PF), 6.7% yield, 15% upside, S&P BBB   

W.R. Berkley 5.70% Series E (WRB-PE), 6.4% yield, 12% upside, S&P BBB-   

Each listing includes these definitions

Coupon Rate: preferreds annual interest rate based on $25 per share issue price.

Market Yield: annual interest rate youd earn based on recent trading price.

Upside: capital appreciation potential should the preferred trade back up to its $25 issue price.

S&P credit rating

One more thing you need to know: preferred stock ticker symbols are not standardized and vary from site to site. However they typically start with the issuer's common stock symbol and end with the series designator. For instance, the ticker for Bank of America (BAC) Series M preferreds might be BAC-M, BAC-PM, BACPRM, etc. Our listings use Yahoos ticker symbols. When youre ready to buy, use your brokers symbol lookup function.

As usual, those are my ideas. Do your own research. The more you know about a pick, the better your results.

published 9/18/23

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