September 7, 2012
Written By Chloe Lutts Jensen
As retired investors are quickly learning in today’s super-low-interest-rate environment, there are lots of ways to create a fixed income portfolio without using the traditional bonds. I’ve already discussed REITs, utilities, MLPs and a variety of other investments here, and today I add one more vehicle to the list: preferred stocks.
Preferred stocks are a special class of shares issued by companies that rest somewhere between fixed-income obligations (bonds or notes representing loans) and common stocks. Harry Domash, editor of Dividend Detective, summed up some of the salient features of preferreds in his recent recommendation of preferred stock issued by Annaly Capital Management.
“This month, we’re adding Annaly Capital Management, Inc. 7.625% Series C Cumulative Redeemable Preferred Stock (NLY-C) to Dividend Detective’s Preferred Stocks portfolio. Annaly is a real estate investment trust (REIT) that invests in single-family, adjustable-rate and fixed-rate mortgage-backed securities guaranteed by U.S. government agencies such as Fannie Mae and Freddie Mac. Thus, the U. S. government, not Annaly, takes a loss if a homeowner defaults.
“If you haven’t bought preferreds, here are some things that you need to know. Although traded like common stocks, preferreds are more like bonds in that they represent debt, not ownership. Consequently, you buy them for the steady income, not capital gains. Most preferreds, including Annaly’s Series C, are issued at $25.00. Preferreds issued at that price typically trade in the $23 to $27 range depending on market conditions and how the market feels about the outlook for the issuing company. Issued on May 16, 2012, Annaly’s Series C preferreds recently traded at $26.10.
“As is the case for most preferreds, Annaly’s Series C are ‘callable,’ meaning that Annaly has the right to call (redeem) them at the ‘call price,’ which is $25.00, the same as the original issue price. Annaly Series C are callable on May 16, 2017. Annaly doesn’t have to call its preferreds on that date. In fact, many preferreds are not called for years after their call dates.
“However, if you pay $26.10 per share, you would lose $1.10 on the share price when they are called. Taking that into account, your yield to call (average annual return) to the May 2017 call date (yield to call) would be a still attractive 6.5%. Your yield would be even higher if Annaly didn’t call them on that date.
“Unlike common stocks, preferred ticker symbols are not standardized. Your broker may use a different symbol. Enter Annaly Capital into your broker’s symbol lookup function to see a list of Annaly’s preferreds.”—Harry Domash, Dividend Detective, August 23, 2012
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In addition, preferred dividends are better protected than common stock dividends, both in and out of bankruptcy. While preferred stock dividends still have to be “declared” by a company’s board quarter-to-quarter or year-to-year (unlike bond distributions, which are mandated), they are paid before dividends on the common stock. And in bankruptcy, preferred stockholders’ claims over the company’s assets are superior to ordinary stockholders’.
Preferred stock dividends are also usually “cumulative,” meaning that if the company doesn’t pay some (or all) of its promised distributions, investors will receive them at a later date. The unpaid portion is considered “dividends in arrears” and must be paid before any other dividends. Check to make sure your preferred is “cumulative” to see if it has this feature. If it’s “non-cumulative,” skipped dividends don’t have to be made up.
Some preferred stock is also “convertible,” meaning it can be converted into ordinary stock on or after a given date. This option gives preferred stock more potential upside.
One downside to preferred stock is that preferred holders usually don’t have voting rights as common stockholders do.
The details of preferreds can vary quite a bit, but the information can often be easier to find than details on bonds. Just be sure to do your research, whether that’s by reading about preferreds in a newsletter (like the Dividend Digest, Harry Domash’s Dividend Detective, or others) or by asking your broker.
Wishing you success in your investing and beyond,
Editor of Investment of the Week
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