WASHINGTON, April 10, 2013 – The market is indulging in another bout of irrational exuberance this morning, up roughly 80 Dow points as of this writing. The Maven has dumped the rest of his ill-advised short ETFs and vows not to try this move again until this market is in the midst of a confirmed tailspin. As long as the Fed is unloading helicoptersful of Benjamins, any shorting is just too treacherous any more, a situation that may only otherwise change if North Korea’s latest Kim succeeds in unloading a dirty nuke on Austin, Texas, as he’s threatened. Then, even gold might finally look good again.
We are simply not going to chase stocks here, and instead, are picking carefully back into the REITs we unwillingly dumped last month as investors seemed to be rotating out of them. Likewise, select MLPs, even though this guarantees another paperwork nightmare for us when filing those 2013 returns next April.
Meanwhile, we continue to look upon preferred stocks as a way to sweeten the portfolio’s yield while we await the seemingly inevitable May downturn in the markets. These stocks are excruciatingly boring for those who like a lot of trading action. But, with the Fed’s actions driving bond prices down and eroding premiums for other high-yielding investments like REITs, we need to broaden our hunt for yield, and preferreds might just be the place to look, as we’ve done many times before.
New and old preferred stocks are mostly issued by traditional financial companies like banks and insurance giants. But some REITs have gotten into the act as well, as have other companies that are involved at least peripherally in real estate.
Bottom line: issuing trust-preferred and preferred stocks is a traditional way for banks to raise capital at a relatively low “interest rate” (even though preferreds pay a dividend since they’re stocks). With trust-preferreds going away under Dodd-Frank, a great way to refinance the debt they represent is by rolling them over and replacing them with regular old preferred like we used to have—and at lower yields to boot. Yet these rates are still better than the interest you can get on most common stocks. Plus, preferreds are senior to common stock, and, if a company is forced by the economy to cut or eliminate dividends on its common, preferred dividends don’t go on the chopping block until the common suffers first.
Most but not all preferreds are issued at a nominal price of $25 per share. The dividend percentage, which almost never changes in a preferred, is based upon this $25 price. Once the stock trades, of course, the price can fluctuate up and down.
If you can get these stocks below $25 at any time, you’re buying the yield at a discount and your yield percentage will be higher. If you’re buying the stock above $25 (known as “par value”), however, you’re buying it at a premium, and your effective yield will be lower than the nominal yield at $25. But the actual amount of the dividend won’t change, making this investment seem a lot like a bond.
Preferreds are not stocks in which you can usually make a capital gain, since they tend to trade on yield, like bonds. But if you can get them at a discount during market plunges, you can often get a sweet deal. The Maven scooped earlier preferred issues up, along with select junk bonds, in a near-suicidal move right at the March 2009 market bottom. His remaining holding from that period—a Zions Bank preferred (ZB/PRC)—trades somewhat above par today, but was purchased at about $15 per share, a huge discount.
The reason it’s desirable to get preferreds like these at a discount is simple. Unlike most common stocks, preferreds at some point can and will be called. With a little exploration (a bit more on this in a minute), you can find out what the magic date is, usually 5-10 years after the preferred is issued. Interest rates can change over time as we’ve seen; and when they go down, issuers of preferreds like to “refinance” by issuing new preferreds at lower rates as they retire the older, higher-yielding ones. Issuers of bonds with “call” provisions do the same thing.
But back to that discount. When preferreds are called, they’re called and redeemed at par, i.e., $25 for most of them. If you bought them at a discount, you’ll also get a reasonably nice capital gain when they’re called, adding a nifty kicker to that swell money you’ve been getting quarterly for years. If you bought them at a premium, however, i.e., over $25, you’ll only get $25 when you’re called.
Note that these stocks are generally not for trading. Many of them have fairly small “floats” or shares available for trading publicly. As a result, the bid-ask spread can sometimes be maddeningly wide, and you run some risk of buying or selling at a slightly less-than-optimum price. So we advise choosing preferreds that have a fairly large trading float.
Preferred stocks are, contrary to current wisdom, perhaps the last of the true “buy and hold” situations worth owning if you need regular income.
If you like the idea of preferreds but hate to do all the work, there are at least a couple of ETFs that invest in a basket of these things. Yields tend to be relatively stable, and these ETFs are fairly safe ports in a storm during stock market gales. One good one we’ve held for some time now in one of our portfolios is PFF. Another decent ETF we’ve discovered (and invested in) lately is PGX.
For more in-depth information on various companies’ preferred, including links to the prospectuses (prospecti?) of the newer issues, visit QuantumOnline, a site where you can research various preferred stocks via the “mother stock’s” ticker symbol which you will need to know. (Note that some preferreds actually use a somewhat different symbol than the mother stock uses.) At this site, you can also find out when dividends are paid for a given issue and other interesting stuff.
Disclaimer: The author of this column maintains several active trading and investment portfolios and owns residential and investment real estate. He intends to nibble on the preferred stocks mentioned above as the occasion warrants.
Positions mentioned above describe this author’s own investment decisions and should not be construed as either buy or sell recommendations. The current market is highly treacherous and all investors travel at their own risk, so caution should be exercised at all times.
Illustrations, charts, commentary, and analysis are only the author’s view of current or historical market activity and don’t constitute a recommendation to buy or sell any security or contract. Views, indications, and analysis aren’t necessarily predictive of any future market or government action. Rather they indicate the author’s opinion as to a range of possibilities that may occur going forward.
References to other reporters, analysts, pundits, or commentators are illustrative only and do not necessarily represent an endorsement of such individuals’ points of view. If specific investment vehicles are mentioned in any article under this column heading, the author will always fully disclose any active or contemplated investments in said vehicles.
Read more of Terry’s news and reviews at Curtain Up! in the Entertain Us neighborhood of the Washington Times Communities. For Terry’s investing and political insights, visit his Communities columns, The Prudent Man and Morning Market Maven, in Business.
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