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.
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.
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.
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 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
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.
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
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.
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