Preferred Stock 301+Advice to the Advisor
(As an advisor, you’re in the know, but perhaps your clients can use a 101+ quick “cheat sheet” on Preferred Stock). Then, keep reading for some more advanced insights …
By issuing preferred stock, a company combines the characteristics of both debt and equity. Advantages to the issuing company include:
- Issuing preferred stock as opposed to bonds keeps the company’s debt-to-equity ratio lower, a situation favored by investors.
- Ratings agencies tend to give a more favorable analysis for preferreds as opposed to bonds.
- Preferred dividends may be suspended if needed without forcing the company into bankruptcy giving the company some cash flow flexibility.
Advantages to individual investors when choosing preferred stock:
- Yields on preferreds tend to be higher than those on bonds, money market funds, or common stock.
- Preferred stock has low correlations with common stock (preferreds can be a good way to diversify risk).
- Many preferred stock distributions classified as “qualified dividends,” which are taxed at capital gains rates.
Yield is measured in two general ways: Current Yield (annual dividends divided by current price) and Yield to Call (yield if the security is called.)
Some types of Preferred Stock:
For advisors who do not wish to involve themselves in the selection and trading process, Sheaff Brock offers the active management we believe is key to successful and ongoing preferred stock investing. The Sheaff Brock Preferred Income portfolio consists largely of $25 par retail preferred securities with the addition of some $1,000 institutional preferred stock. There are many factors to consider when managing the portfolio such as:
- credit rating
- yield to call
- option-adjusted spread
Diversification is always an important factor in building a portfolio, and top holdings in the Sheaff Brock Preferred Income Portfolio represent a variety of sectors, including finance, real estate, global and U.S. banking, credit services, and utilities, with the overriding goal being to generate consistent income while seeking preservation of capital, Sheaff Brock Senior Portfolio Manager JR Humphreys stresses.
Two risks that need to be addressed when managing a preferred equity portfolio is interest rate risk and credit risk. A recent shift Humphreys saw related to interest rates was the abrupt change in the Federal Reserve’s interest rate outlook. The Fed went from increasing the federal funds rate in late 2018 to lowering the rate in 2019. Interest rates go hand in hand with the economy which affect the credit worthiness of corporate America. In addition to interest rate risk, credit risk must also be managed. This is especially important if the economy slides into a recession. Do the recent interest rate movements point to a recession or has the Fed adjustment delayed the next recession?