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High Quality Preferred Stocks

Preferred Stock News

Special Announcement

Preferred Stock Facts

FREE Special Offer

For New Readers...

Welcome to all of the new CDx3 Newsletter readers who signed up over the last month. This is your first issue of the CDx3 Newsletter, a free monthly newsletter devoted to the interests of CDx3 Preferred Stock investors.

To be sure that you continue to receive the CDx3 Newsletter each month, please remember to add the following email address to your email address book safe sender list:

CDx3NotificationService@us.emaildirect.com.

What Is A "CDx3 Preferred Stock?"

CDx3 Preferred Stocks are regular preferred stocks that are able to meet the ten selection criteria described in chapter 7 of my book, Preferred Stock Investing.

Applying the CDx3 Selection Criteria eliminates the pretenders, leaving just the highest quality issues.

For example, here are three of the ten CDx3 Selection Criteria:

1. be issued by a company with a perfect record of never having suspended a dividend on a preferred stock;

2. have the "cumulative" dividend requirement, which means that in the unlikely event that the issuing company misses a dividend payment to you, they have to make it up to you later; they still owe you the money; and

3. be rated "investment grade" by Moody's Investors Service.

Having specific and consistently applied selection criteria takes the emotion out of your investing decisions and leaves you with the highest quality preferred stocks - "CDx3 Preferred Stocks."

Quick Summary

This month's High Quality Preferred Stocks article explains how three criteria, when applied to the 1,000+ preferred stocks trading on U.S. stock exchanges, allow you to identify the highest quality issues. The table in this article takes the analysis a step further by itemizing 7 of these high quality issues that can be purchased today for a market price that is less than $25 (par). (jump to article)

The Preferred Stock News article looks at historical data to answer a common question currently on the minds of preferred stock investors: If I invest in today's high quality preferreds stocks, offering an average annual yield of 6.8%, how much do I need to worry about a future increase in interest rates wiping out my gains? (jump to article)

The Special Announcement article explains how you can now have continuing preferred stock research delivered to you for free. Why wait until next month's CDx3 Newsletter to find out what is going on in the preferred stock marketplace? Throughout the month I post regular research articles on the Preferred Stock Investing Reader's Forum and make them available to you for free. (jump to article)

The Preferred Stock Facts article is presented both here and on the Preferred Stock Investing Reader's Forum. Test your knowledge by clicking on any preferred stock question to see the multiple-choice answers. You will receive an automatic email that provides you with the correct answer and my explanation. (jump to article)

In the Free Special Offer article I offer to provide you with some of the research from my book, Preferred Stock  Investing, Fourth Edition. I am making it available to brokers, financial planners and investment groups for free. (jump to article)

Enjoy this month's issue. I look forward to reporting back to you in next month's issue of the CDx3 Newsletter.

Learn To Screen, Buy and Sell The Highest Quality Preferred Stocks

Preferred Stock Investing includes the information, websites and other resources needed for you to be a very successful preferred stock investor. The Fourth Edition is now available at your favorite online retailer. For those who would rather someone else do the research and calculations, I offer the CDx3 Notification Service. Subscribers to the CDx3 Notification Service receive an email alert when there are buying and selling opportunities coming up. Subscribers also receive their own non-promotional preferred stock research newsletter every month, have their own website that hosts the CDx3 Preferred Stock Catalog and have access to the CDx3 Discussion Group, the only online forum just for preferred stock investors.

Invest in the best. Subscribe to the CDx3 Notification Service today.

How Afraid Should You Be Of Increasing Interest Rates?
See What Happened To Preferred Stock Prices The Last Time We Faced Increasing Rates

Preferred stock investors are rightly concerned that when interest rates start going up (2015?), the market prices of their preferred stock shares will go down. Interest rates and the market prices of fixed-income securities (bonds, preferred stocks) tend to move in opposite directions.

But on the upside, high quality[1] preferred stocks are currently offering one of the best returns available. Today's fixed-income alternatives look something like this:

- Bank Certificates of Deposit (national average, 24 month APY): 1.1%
- Corporate Bonds: 4%
- High Quality Exchange Traded Debt Securities: 6.5%
- High Quality Preferred Stocks: 6.8%

Taxes and inflation wipe out the first two.

If you avoid investing in high quality preferred stocks at today's 6.8%, are you making the right call? How much would future prices have to drop anyway, and how likely is that?

Rate Increase in 2015 (?)

The Federal Reserve has announced several times that it is not going to be raising interest rates until at least late-2014. That's at least ten quarters from now. By investing at today's average dividend rate of 6.8% for the next ten quarters you will earn $4.25 per share in dividend income[2].

Should preferred stock investors walk away from today's 6.8% for fear that a future interest rate increase will lower prices enough to wipe out their gains?

Let's take a look at what happened to high quality preferred stock market prices the last time the Federal Reserve started increasing interest rates (namely, the federal funds rate).

Before jumping into this analysis, it is important to note that the relationship between the federal funds rate and preferred stock market prices is not a perfect one. There are a multitude of "costs of money" at various levels within the U.S. economy that are each affected by a variety of circumstances, events, policies and other cross-currents (domestic and foreign).

We have to look no further than the recent Global Credit Crisis (2007 - 2009) for an exception to the usual inverse relationship between interest rates and preferred stock market prices (rates down, prices up and vice versa). During the crisis, the Fed lowered the federal funds rate to zero but, for much of this same period, preferred stock market prices dropped as well.

But for this analysis, the federal funds rate suits our purposes fairly well since this is the rate that investors are watching and will react to in the event of a change (or even the announcement of a pending change) probably more so than any other single rate.

Study Period: July 2004 through June 2006

The idea here is to find a recent period that is arguably comparable to today's circumstances where the Fed increased the federal funds rate, and then see what happened to the market prices of high quality preferred stocks during that period.

July 2004 through June 2006 provides an excellent study period[3]. Going into this period, the average dividend rate being offered by high quality preferred stocks was 6.8% (same as today); the federal funds rate was at a historically low level and had been there for a long time (also similar to today); the Fed started increasing rates for the policy objective of holding off inflation as the post-9/11 economy recovered (which is likely to be the same policy reasoning come 2015); and they did so in very minor 0.25% increments that were announced in advance as to not introduce an unwanted shock (which is also likely to be the case come 2015).

As illustrated in Figure 1, beginning in July 2004, under Chairman Alan Greenspan, the Fed gradually and very steadily increased the target federal funds rate for 24 straight months. Beginning at 1%, the federal funds rate was increased to 5.25% twenty-four months later with no breaks in between. Because of this consistent, steady and prolonged rate increase, preferred stock market price data from this period is nearly pristine.

Preferred Stock Market Prices

So what happened to preferred stock market prices the last time the Fed started increasing rates?

Figure 2 shows the monthly average market price of high quality preferred stocks during the same period, July 2004 through June 2006[4].

Interestingly, preferred stock market prices actually increased for several months when the Fed started raising rates in July 2004 (perhaps because the rate increase was not as significant as investors had feared).

Also note that, while prices definitely dropped over this period of increasing rates[5], they did not fall below their $24.81 starting point until October 2005, fifteen months after the Fed started increasing rates.

The result of this significant increase in the federal funds rate was an $0.82 per share drop in the average market price of high quality preferred stocks (from $24.81 to $23.99).

Preferred stock investors who chose to purchase high quality preferred stock shares going into this study period had earned an average of $2.55 in dividend income 24 months later. These investors gave up $0.82 in value to gain $2.55 in dividend income over the study period.

Back To Our Original Question

So back to our original question: If you avoid investing in high quality preferred stocks at today's 6.8%, are you making the right call? How much would future prices have to drop anyway, and how likely is that?

Because we are talking about the future here, the short answer is that there is no way to know for sure. It is hard to say how meaningfully past events will apply to the future.

But remember that just as the direction of interest rates and preferred stock prices are related, the same is true of magnitude. Minor and gradual rate changes tend to have a minor and gradual impact on prices.

Once the Fed starts raising interest rates, do you think it is more likely the any such increase will be (a) huge, sudden and unannounced or (b) minor, gradual and announced in advance as to avoid shocking what is sure to be a fragile economy coming out of recession?

Assuming that future rate increases are more likely to be minor and gradual, it is doubtful that a resulting price drop would be major and sudden.

To the extent that we can apply our study period to a 2015 rate increase, it seems unlikely that a 2015 rate increase would erode market prices enough to offset the $4.25 per share in dividend income that preferred stock investors will collect between now and then.

Footnotes:

[1] "High quality" preferred stocks are those that meet the ten risk-lowering selection criteria from chapter 7 of my book, Preferred Stock Investing. For example, high quality preferred stocks have investment grade ratings and the cumulative dividend requirement.

[2] A 6.8% preferred stock with a standard par value of $25 pays a dividend of $0.425 per quarter (($25 x 6.8%) /4). $0.425 per quarter for ten quarters is $4.25 per share in dividend income. All such values used throughout this article are per share.

[3] While this is the best and most recent period to compare, keep in mind that there are significant differences between the preferred stock market as it existed then versus today. For instance, Big Bank trust preferred stocks (TRUPS) dominated the offerings then. But due to the January 1, 2013 implementation of Section 171 of the Wall Street Reform Act, that will not be the case come 2015.

[4] Source for all preferred stock data in this article: CDx3 Notification Service database, TDAmeritrade, Preferred Stock Investing, Fourth Edition. The CDx3 Notification Service is my preferred stock email alert and research newsletter service including data for all preferred stocks and Exchange Traded Debt Securities traded on U.S. stock exchanges.

[5] Chapter 15 of Preferred Stock Investing, Fourth Edition itemizes every high quality preferred stock that has been issued since January 2001. High quality preferred stocks used for this price analysis were taken from the chapter 15 tables.
 

Test Your Knowledge With These Preferred Stock Facts!