Preferred shares are often overlooked by dividend investors because of their lower growth rate as compared to common shares. Since they have a higher dividend yield, and preferred shareholders have rights to dividends over common shareholders, they certainly are worth looking into. The key point is preferred shareholders give up their voting rights in favour of a higher yield. In addition preferred shares are more complex than common stock, and have similar characteristics to corporate bonds that make purchasing them also more complex. However if you like high dividend yield with less market volatility, then preferred shares can make an excellent addition to your portfolio.
Yield versus Growth
The higher yield of preferred shares can be viewed as either an advantage or disadvantage – depending on your perspective.
If you are older (50’s+) and want steady income without market volatility, then preferred shares are an excellent choice for the growth section of your portfolio. The top 14 Canadian preferred shares I reviewed (see table below) had on average nearly twice the yield of common shares, but with 25% less volatility in share price. In real terms that was an average of 5.9% dividend yield, with 10% growth in share price over a 52 week period – or 15.9% average total return.
On the other hand if you are younger (20’s to 30’s) and after growth oriented investments, then buying preferred shares would be pointless. Take for example the same table results below. Common shares returned half the yield of preferred shares at 3.3%, but gained a spectacular 40% return in capital appreciation over the last 52 week period. This was nearly 4 times as much capital appreciation as preferred shares. The average 52 week total return was 43.3%.
Of course the last 52 weeks has seen exceptional stock market gains. So where preferred shares will obviously be nice to hold is during market declines or sideways markets, since you will get a high yield with less share price decline. That’s where investors who hold preferred shares will have the advantage. So holding preferred shares can be viewed as a defensive move in sideways and bear markets – but less of an opportunity in bull markets.
For companies where several preferred shares series existed I simply chose the one with the highest dividend yield. A brief description of the symbols and stats used:
- PS = Preferred Shares
- CS = Common Shares
- Yield = The annual dividend yield
- Growth = Percentage change from 52 week low to 52 week high
- Ratio = The total return of CS (yield + growth) / PS (yield + growth)
|Company||PR Symbol||PR Yield||PR Growth||CS Symbol||CS Yield||CS Growth||Ratio|
|Bank of Montreal||BMO.PR.O||5.9%||7.92%||BMO||4.9%||28.56%||2.42|
|Canadian Western Bank||CWB.PR.A||6.6%||6.34%||CWB||1.8%||51.38%||4.11|
|George Weston Limited||WN.PR.A||5.8%||16.43%||WN||2.0%||28.94%||1.39|
|Laurentian Bank of Canada||LB.PR.D||5.9%||11.48%||LB||2.9%||42.45%||2.61|
|Manulife Financial Corp||MFC.PR.D||6.0%||7.78%||MFC||2.9%||86.20%||6.47|
|National Bank of Canada||NA.PR.O||6.0%||8.98%||NA||3.6%||33.60%||2.48|
|Power Corp of Canada||POW.PR.C||5.8%||18.01%||POW||4.1%||26.10%||1.27|
|Royal Bank of Canada||RY.PR.R||5.8%||6.70%||RY||3.6%||28.74%||2.59|
|Sun Life Financial Inc||SLF.PR.F||5.6%||7.15%||SLF||4.3%||45.80%||3.93|
|Toronto Dominion Bank||TD.PR.K||5.7%||7.30%||TD||3.1%||24.19%||2.10|
With preferred shares you really have to do your research and understanding what exactly you are buying. That generous yield may come with some strings attached that may not be so profitable – so be prudent and do your research. First put the stock symbol i.e. TD.PR.K into Google and look for the company news release on that stock. There you can find the detailed information on that issue.
Consider the following characteristics of preferred shares when doing your research:
An adjustable-rate preferred stock pays a dividend (usually quarterly), that is based on a current interest rate benchmark. This is advantageous over a fixed rate preferred stock, where interest rates are rising.
If any dividend payments are missed by the company, all dividends of all missed payments must be paid for cumulative preferred shareholders before any common shareholder.
The convertible feature allows the shareholder to convert their preferred stock to common stock at any time. This is advantageous where the common stock price has risen sharply, and a significant profit can be realized. The Convertible feature is a benefit to the shareholder.
Most preferred shares are callable (redemption dates). This feature allows the company to call back the preferred stock at a specified price, termed the call price. That call price can easily be lower than the current price of the stock – a losing scenario should the company exercise its option . This is a benefit for the company and not the shareholder. You have to watch the call dates carefully and sell accordingly or convert to common shares (if the convertible option is available).
Preferred Shares are Not Bonds
There seems to be a misconception among investors that Preferred Shares are a replacement for Bonds because of the similar characteristics they posses (i.e. adjustable, callable, convertible etc.). But this is simply not the case, preferred shares are not a replacement for bonds or the fixed-income section of your portfolio – in fact they are growth investments. The Canadian Couch Potato addressed this issue in his Debunking Dividend Myths series. The fact is a corporation can refuse dividend payments on both common stock and preferred shares at its discretion, but it cannot default on its bond payments.
However like Bonds, the price of preferred shares will increase as rates go down, and conversely the price will decrease as rates go up. This isn’t set in stone like bonds, but in the past that has been the pattern. So with record low interest rates preferred shares may not be so prudent, even with the high yields.
Where investors also get confused is the rate set for preferred shares, which is based on the interest rate when the stock was issued. Basically a company needs to issue a preferred share at a competitive rate to current interest rates. Otherwise investors would simply buy bonds and t-bills. That’s also due to the fact that preferred stock does not have the same level of capital appreciation potential as common stock.
While preferred shares are a more conservative investment, and have some features that bonds possess, that’s where the similarity ends. Simply put, it would be foolish to replace your fixed income assets with preferred stock.
When purchasing preferred shares it is vital to understand the concepts of: adjustable, cumulative, convertible, callable, and the fact that preferred shares are non-voting. Preferred Shares have callable dates. You can lose money if the corporation buys back their shares. Also while preferred shares appear to mimic bonds, they are in fact not bonds and are growth investments. They should not replace the fixed income section of your portfolio.
In concluding, preferred shares provide an exceptional dividend yield (twice the yield of common shares) with less market volatility. Therefore they are well suited to an older investor, or an investor who is willing to forgo long term capital appreciation – for higher dividend yield. However one has to be aware of the strings attached.
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