You don't have to watch the market every day in order to identify potential bargains for CDx3 Preferred Stocks*. There's a simple two-step analysis that makes underpriced CDx3 Preferred Stocks jump right off the page, and I'm going to show you how to do it.

The foundation for this analysis is that all investors are looking for the same thing - the highest return for the lowest risk.

Usually, "The Market" (you and me) sets the market price of a CDx3 Preferred Stock in accordance with its perceived risk. But not always; some times The Market prices a CDx3 Preferred Stock too low, creating a buying opportunity for you. And that's where this analysis comes in.

The first step is to identify CDx3 Preferred Stocks -  which are, by definition, the highest quality preferred stocks available - where The Market appears to have misjudged the investment risk.

The Market assesses risk based on (1) knowledge of the facts and (2) emotions, such as fear or elation. Rating agencies, such as Moody's Investors Service, use a variety of statistical models to assess risk based on knowledge of the facts that leave out the emotion.

By comparing how The Market assesses the risk of a CDx3 Preferred Stock versus Moody's, one can quickly see inconsistencies. These inconsistencies represent opportunities for CDx3 Investors.

The "yield" of a CDx3 Preferred Stock investment at any point in time is a reflection of the risk of that investment as assessed by The Market. The Moody's rating of that same CDx3 Preferred Stock is the result of Moody's risk assessment.

Example: If you look at two CDx3 Preferred Stocks that have the same Moody's rating, you would expect that The Market has priced them such that they have the same yield (since the risk is the same, as assessed by Moody's). PSA-L (6.75%) and PSA-M (6.625%) from Public Storage both have an investment grade Moody's rating of Baa1. At this writing, the market price of PSA-L is $21.35 while that of PSA-M is $20.72. These market prices produce a "yield" of 7.9% for both PSA-L and PSA-M, as we would expect - same risk, same yield. The Market and Moody's agree.

Here is a chart that subscribers to the CDx3 Notification Service recently received that compares The Market's assessment of risk (yield) for select CDx3 Preferred Stocks to that of Moody's.

Each diamond on this chart represents a CDx3 Preferred Stock. The ten Moody's investment grade subcategories run across the bottom. CDx3 Preferred Stocks with the same risk rating should produce the same yield. Where The Market and Moody's agree on investment risk, the diamonds that you see above a given Moody's rating should be grouped together (such as those that Moody's has rated Aa3).

And notice that they are - expect for those rated A3 and Baa1 by Moody's. Note The Market's confusion at the Baa1 risk level; The Market has no idea how to assess the investment risk related to these CDx3 Preferred Stocks. Yields vary from 8% to 17%.

Now look at the A3 risk level. Moody's is saying that there are three CDx3 Preferred Stocks at this risk level (labeled A, B and C on the above chart). The Market does not agree. The Market is saying that CDx3 Preferred Stocks A and B have much more investment risk than CDx3 Preferred Stock C (the yield of A and B is higher because The Market has set their market prices lower than C even though Moody's is saying they all have the same risk level). 

This analysis has told us that either The Market or Moody's (or both) has blown the call at the A3 risk level. Either C is overpriced (producing a lower yield) or A and B are underpriced for the level of investment risk that Moody's is saying these CDx3 Preferred Stocks represent.

So which is it? That brings us to the second step where we take a closer look at the market prices of these three CDx3 Preferred Stocks.

The current "going dividend rate" for CDx3 Preferred Stocks is 8.729%. Since new CDx3 Preferred Stocks sell for a market price of about $25, we can draw a “constant yield line” on this chart showing a constant yield of 8.729%; just as a CDx3 Preferred Stock that pays 8.729% and sells for $25.00 yields 8.729%, so does a CDx3 Preferred Stock that pays a 6.5% dividend selling for a market price of $18.62.

CDx3 Preferred Stocks that occur on, or close to, the constant yield line can be said to be properly priced by The Market. The Market has overpriced those seen to the right of the line and underpriced those to the left of the line, given the risk as assessed by Moody's.

Remember, CDx3 Preferred Stocks A, B and C all carry the same investment risk (A3, according to Moody's).

Notice how CDx3 Preferred Stock C falls right on the constant yield line; this CDx3 Preferred Stock is being properly priced by The Market.

But look at CDx3 Preferred Stocks A and B. Given the level of investment risk (A3), these two CDx3 Preferred Stocks are currently being underpriced by The Market and, therefore, may represent outstanding purchase opportunities for CDx3 Investors.

So, one of the tools that CDx3 Investors can use to find real bargains is to (1) identify CDx3 Preferred Stocks that The Market appears to have mispriced at a given level of investment risk, then (2) see which of those are to the left of the constant yield line.

The result is the identification of CDx3 Preferred Stocks that The Market has underpriced, given the level of investment risk.

You can do this analysis on your own by following the steps I've laid out for you, or let us do it for you by subscribing to the CDx3 Notification Service. Subscribers, of course, also get to know the trading symbols of these CDx3 Preferred Stocks.

* CDx3 Preferred Stock: CDx3 Investors are only interested in the highest quality preferred stocks and there are lots of pretenders to weed out. Applying the CDx3 Selection Criteria (Preferred Stock Investing, Chapter 1) will eliminate about 90% of the regular preferred stocks trading on today's stock market.

To be considered a "CDx3 Preferred Stock," regular preferred stocks must:

1.  be rated "investment grade" by Moodys;

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

3.  have the "cumulative" dividend requirement, which means that in the unlikely event that the issuing company misses a dividend payment to you (which I have never seen happen with a CDx3 Preferred Stock), they have to make it up to you later; they still owe you the money.

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."

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