Lessons from the Pros

Proactive Investor

More on Preferred Stock Yields

My last article was called Understanding Bond and Preferred Stock Yields.  In that piece, I described the differences between the yield measures known as Coupon Rate, Current Yield, Yield to Maturity and Yield to Worst. Today I’ll expand on that, emphasizing preferred stocks this time.

I’ve written about preferred stocks in earlier articles, as potential income-generating investments. There are around 450 U.S. preferred stocks available altogether. They pay dividends at a rate that is higher than bond interest; and in some cases, the dividend income is taxed at capital gains tax rates. Bond interest is taxed at ordinary income tax rates.  Most preferred stock is priced around $25 a share, making it is easy to create a diversified portfolio of several different preferred stocks, even with a small amount of money to invest.

On the negative side, preferred stockholders do not get to vote; their dividends are never raised; they come behind bondholders in the event of a liquidation of the company; and preferred stock prices do not go up when the company’s earnings and common stock prices do. If, in your mind, all those negatives are outweighed by the positives, then U.S. preferred shares should be on your radar.

Below is a small subset of a listing of the available preferred stocks, chosen more or less at random to illustrate the points that I want to talk about today concerning yield calculations. As the red text indicates, no recommendation for or against is implied.

Identifying a bad preferred stock investment.

Note the stock in the middle of the list, Prologis 8.54% Cumulative Redeemable Preferred. Its Issue/Call Price is $50 per share. Issue/Call Price is roughly equivalent to a bond’s face value, in the sense that if the company does pay off the preferred shares, that $50 per share is the amount the preferred shareholders will receive.

In the column labeled Quar Dividend (Rounded), we see that owners of these shares receive a dividend of $1.07 (it’s actually $1.065) every quarter, a total of $4.27 per year. Hence the Coupon Rate of $4.27 / $50.00, which is 8.54%.

Under Current Price, the value is $70.12. That is the price at which these shares recently were changing hands. The $20.12 per share premium over the Issue/Call price indicates that investors are now willing to accept a yield that’s much less than the coupon rate. That rate was set years ago when these shares were issued, at a time of higher interest rates. At the price of $70.12, the cash-on-cash yield becomes $4.27/$70.12 which is 6.09%, the value shown under Current Yield.

Free Trading WorkshopUnder Earliest Call Date, the date shown is 11/13/26, a bit over 8 years away. Under the terms of the preferred share issue, on or after this date, Prologis can redeem the preferred shares by paying $50 per share. If interest rates are as low at that time as they are now, Prologis would almost certainly redeem them. If they didn’t have the cash to do so, they could certainly sell new preferred shares to raise it, since obviously investors are willing to buy their preferred shares and accept a 6% yield.

When Prologis does redeem the shares, anyone who bought them today at $70.12 would lose $20.12. After allowing for the interest received in the interim, the net return on the shares would still be negative. That’s why the Yield to Worst value of -11.4% is a negative number. It shows that anyone who buys the shares today would lose money if the shares are called on schedule, which is likely. Anyone who does buy them (there are very few – typically fewer than 1,000 shares a day are traded on this particular preferred stock) is betting, whether they realize it or not, that the shares will not be called.

There are many preferred stocks that do not have time bombs embedded in them. And understanding the terms used to describe their yields can help us find them. A simple strategy is to assume that the yield to worst will be the actual yield, and avoid any preferred stock where that is a return that is not acceptable to you. There is more to it than that, but that alone would steer you away from many opportunities that seem good but may not be, and toward the really good ones.

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.