I’m grateful to Rob Carrick for kindly quoting me in his piece Amid a long bear market for preferred shares come glimpses of why you might want them in your portfolio:
“Common share dividends can be cut quite easily,” said James Hymas, president of Hymas Investment Management Inc. and an authority on preferred shares. “Preferred share dividends can only be cut when the common share dividend goes to zero.”
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The preferred share index was down more than 30 per cent from its pre-pandemic peak to its March 23 trough, but then bargain hunters stepped in. “There was a growing sense that the yields available were completely ridiculous,” Mr. Hymas said. “At the bottom, you had the bluest of the blue chip companies yielding 7 per cent on their dividends.”
A quick refresher on falling share prices and dividends: When stocks fall in price, their dividend yield rises. Mr. Hymas said that six months ago, rate reset preferred yields were in the 5.5 to 5.75 per cent range.
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Preferred share dividends are more secure than common share dividends, but defaults have happened in rare cases. Mr. Hymas said these defaults are rare because the total amount of preferred share dividends paid out by companies tends to be a comparatively small corporate expense. Also, a company is considered to be financially failing when it suspends preferred share dividends. “It is extremely difficult for a company to get financing once it has pulled that trigger.”
There are two main types of preferred shares – rate resets and perpetuals, which pay a fixed dividend. Perpetuals typically behave more like bonds, rising in price when rates fall and losing ground when rates rise. However, Mr. Hymas said perpetuals have been lumped in with rate resets lately and have not done well, either.
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Why consider rate reset preferreds at all, then? Mr. Hymas says their yields are attractive now and would remain so even if they undergo a dividend reset at today’s depressed rates. And, as we wait for the pandemic’s impact on the economy to hurt corporate profits, there’s the added level of security over common share dividends.
The do-not-ignore caveat: Forget about preferred shares altogether if you want a secure investment that doesn’t change much in price. “Preferred shares are volatile beasts and you shouldn’t buy them for preservation of capital,” Mr. Hymas said. “They are all about preservation of income.”
It is a pity that the article uses Current Yield to illustrate the reward side of the case in favour of preferreds, instead of calculating the yield properly as with the yield calculator for Resets. This inaccuracy is particularly glaring with respect to BAM.PR.B, a Floater paying 70% of Canada Prime based on par, so (2.45% * 70%) * 25 = 1.715% * 25 = 0.42875 p.a. The article touts a Current Yield of 9.1% at a price of 7.64, implying a dividend rate of $0.69524 p.a., or 2.78% of par, implying Canada Prime of 3.97% …. this is consistent with the March dividend of $0.172813 … prime hit 3.95% in October 2018 and was reduced to 3.45% in early March 2020 and then to 2.95% in mid March 2020 and then to 2.45% in late March 2020. Some people are going to be awfully disappointed.