PREFERRED
STOCK NEWS
Preferred
Stock versus Common Stock Investing Results
The common
stock market, as reflected by the S&P 500
Index, had a great year last year. The S&P
500 started the year at 1845.86 on January 2
and closed on December 31 at 2058.90, a gain
of 11.5 percent.
One of the primary drivers for last year’s
performance was the failure of the Fed’s
withdrawal from its Quantitative Easing bond
buying program to produce an increase in
interest rates. Since the QE program was
successful in lowering rates, the common
wisdom at the time was that withdrawing from
the program would surely produce the
opposite result and rates would go back up.
In January
2014, the Fed began its much anticipated
taper, slowly backing out of the QE program,
but to no avail; the widely expected rate
increase did not materialize. The cheap
money that U.S. companies had come to love
would continue and common stock prices
surged upward accordingly.
On top of the
11.5 percent value appreciation, 421 of the
500 companies in the S&P 500 Index also paid
dividends with an average current yield of
1.9 percent last year. By adding the two
together (which relies on a bit of imprecise
math), those investing in common stocks last
year earned a total return of about 13.4
percent.
(Sources: S&P 500 values, Yahoo Finance; S&P
500 dividend data, factset.com)
Preferred stock
returns
Preferred
stock investors are generally investing for
the steady income that these securities
provide. With a long-term dividend average
of about 7 percent, daily price fluctuations
are not the primary focus.
But that’s not
to say that value appreciation opportunities
do not present themselves. Importantly, the
market pressures that act upon common stock
prices can often be very different than
those affecting the market prices of
preferred stocks, so you do not want to make
the mistake of assuming that if common stock
prices are heading up or down the same will
be true of their preferred cousins.
For example, the Cyprus clawback event that
occurred during early 2013 pushed U.S.
preferred stock prices up without pressuring
common stock prices. During that event,
citizen savings accounts in Cyprus banks
were raided by the Cyprus government to help
make sovereign debt payments. The resulting
run on those banks turned income investors
there into preferred stock buyers here in
many cases.
But during 2014, the failure of the Fed’s
withdrawal from QE to produce an increase in
interest rates affected preferred stock
prices in the same way as common stock
prices – they both went up. High quality
preferred stocks started 2014 at an average
market price of $23.73 per share.
By high quality, I am referring to those
issues favored by most risk-averse preferred
stock investors – cumulative dividends,
call-protected, investment grade ratings,
etc.
But as it became apparent that interest
rates were not going to be increasing after
all (which would have pushed prices for
fixed-return securities down), income
investors started buying, pushing the prices
of high quality preferred stocks up. By the
end of 2014, the average market price of
high quality preferred stocks was $25.98 per
share, a value gain of 9.5 percent.
The following
chart shows the percent change in market
price for common stocks, as reflected by the
S&P 500 Index, and high quality preferred
stocks throughout 2014.
While the
preferred stock value gain of 9.5 percent
was not as impressive as the 11.5 percent
seen by common stock investors, preferred
stock investors realized substantially
better dividend income throughout the year.
Specifically, while common stock investors
saw 1.9 percent in dividend yield, preferred
stock investors buying shares in January
2014 realized an average of 7.1 percent by
year-end.
(Source: Preferred stock data,
PreferredStockInvesting.com)
Higher reward for
lower risk
For 2014,
preferred stock investors investing in the
highest quality issues saw a combined return
(appreciation plus dividends) of 16.6
percent, compared to 13.4 percent for common
stock investors.
While
outperforming common stock investors,
preferred stock investors were exposed to
substantially lower risk.
Remember that
dividend cash is always paid to preferred
stock shareholders first, before any
dividend payments are made to the same
company’s common stockholders (hence the
name “preferred”).
And note that
this analysis is limited to the highest
quality preferred stocks, which have
cumulative dividends (meaning that if the
issuing company skips a payment to you, they
still owe you the money; their obligation
accumulates). Common stock dividends are, by
definition, non-cumulative meaning that they
can be cancelled at any time, leaving the
shareholder with no recourse whatsoever.
Lastly, where
the highest quality preferred stocks used
here offer investment grade ratings, common
stocks are not rated at all; no quantitative
measure of creditworthiness (the ability to
make future dividend payments) is offered to
those considering buying common stock
shares.
2014 provided
a case of higher returns being realized by
those taking substantially lower risk. As
good as the return provided to common stock
investors was, that seen by those investing
in high quality preferred stock, on average,
was better.
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