PREFERRED
STOCK NEWS
Preferred
Stock: Less Volatility, Better Principal
Protection, Higher Returns at Lower Risk
Usually, the
day-to-day bouncing around of stock prices makes
it tough to compare the volatility of preferred
stocks to common stocks. But the volatility seen
in the U.S. stock market during August was so
extreme that the differences in these two types
of equity securities was amplified, providing an
excellent opportunity to directly compare the
volatility characteristics of the two.
Less Volatility
The market prices
of investments that have a known return do not
tend to bounce around as much as the market
prices of alternatives with lesser known
returns. With a known return, the speculators -
those fairly certain that they know something
that is unknown to others - are removed from the
market.
Further, preferred stocks have a known par
value, usually $25 per share, which is the
amount that shareholders will receive in cash in
the event that the issuing company decides to
redeem the shares (buy back from holders). The
known par value provides another stabilizing
effect on price, especially with preferreds that
are close to, or approaching, their published
call dates.
This chart
illustrates the daily change in the average
market price of U.S.-traded preferred stocks
(blue line) and common stocks (gray line)
throughout August. The standard deviation
measures the degree of variability (volatility),
with common stock prices bouncing around over
five times as much as preferred stock prices
during the month.
Even though August 2015 produced some of the
most volatile equity prices in recent history, a
known return and par value serve as anchors for
preferred stock market prices, a benefit that
common stock shareholders do not enjoy.
Sources: S&P500 values,
SeekingAlpha.com; Preferred stock data,
PreferredStockInvesting.com
Better Principal
Protection
In addition to
being less volatile, the year-to-date average
market price of high quality preferred stocks
has substantially outperformed that of common
stock shares as well. By high quality, I am
referring to those issues favored by most
risk-averse preferred stock investors such as
those with cumulative dividends, call-protection
and investment grade ratings.
Average high
quality preferred prices have only fallen below
their $25.98 per share starting point on one
occasion (June) and are up this year by 0.4
percent, ending August at $26.08. Common stock
prices, on the other hand, gave up earlier gains
and have eroded investor principal by an average
of 3.4 percent.
It is worth remembering that once the Fed begins
raising interest rates (a policy change that has
been a week away for two years now) the market
prices of equities are likely to experience
downward pressure, especially those that offer a
fixed return. For income investors (bonds and
preferred stocks), falling prices represent an
opportunity to buy additional higher yielding
shares at lower prices; for value investors
(common stocks), looking to buy low and sell
high, falling prices frequently represent a
selling opportunity.
Higher Return
There are
currently twenty-three call-protected, high
quality preferred stocks offered by fifteen
companies trading on U.S. stock exchanges. The
following chart compares the dividend yield
being paid by these preferred securities to the
same companies’ common stock shares.
The average dividend yield being offered by the
twenty-three highest quality preferreds is
currently 6.5 percent, whereas the same
companies’ common stocks are offering an average
dividend yield of only 3.7 percent (earlier this
year, factset.com reported that the average
common dividend yield of all S&P500 companies
was 1.9 percent).
The most extreme cases are identified by common
trading symbol on the chart. Health Care REIT (HCN)
has one preferred stock, HCN-J, offering a
current yield of 6.1 percent and a common yield
of 5.1 percent. Goldman Sachs (GS) comes in at
6.2 percent on the preferred scale with a common
yield of 1.4 percent. CubeSmart (CUBE), a
competitor to Public Storage (PSA), has one
preferred stock trading, CUBE-A, with a 7.25
percent preferred yield versus 2.5 percent from
their common stock. CenturyLink (CTL) is the
only case where the company’s common stock is
currently paying more than its average preferred
stock yield – 8.0 percent versus 6.8 percent,
respectively (note that CenturyLink’s preferreds
are actually Exchange-Traded Debt Securities).
As a group,
today’s high quality preferred stocks are
offering almost double the dividend yield of the
common stock shares from the same company. These
results are consistent with those seen
throughout 2014 as well (for 2014 results, see “Preferred
Stock Versus Common Stock Investing Results”,
February 2, 2015).
Source: S&P500 dividend data,
factset.com
Lower Risk
While
outperforming common stock investors, preferred
stock investors are 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.
So far this year,
and like all of last year, the U.S. equity
market has provided a case where high quality
preferred stocks have offered substantially less
volatility, better principal protection and a
higher return at lower risk.
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