Fed Policy Delivers Stable Prices And 7.3% Preferred Stock Dividend Yield

 |  Includes: DIA, PGX, QQQ, SPY
by: Doug K. Le Du

The Federal Reserve's low-to-no interest rate policy has pushed preferred stock investors to the top of the pile for yet another year. For high quality preferred stock shares purchased throughout 2011, preferred stock investors earned about 7.3% at what many would consider to be very low risk. Very few others are making that claim.

Here are the results for high quality preferred stocks, savers (those investing in bank Certificates of Deposit) and common stock investors (as reflected by the S&P 500 common stock index) for 2011.

High Quality Preferred Stock Performance, 2011

Thanks to the Fed's low-to-no interest rate policy, which the Fed has committed to for at least another couple of years, market prices for high quality preferred stocks remained stable throughout the year as did their dividend yields.

As illustrated by Figure 1, the average annual dividend yield from high quality preferred stocks changed very little throughout the year. These securities started 2011 providing an average annual yield of about 7.4% and closed out the year offering just over 7.3%.

High quality preferred stocks are those that meet the ten selection criteria from chapter 7 of my book, Preferred Stock Investing. For example, a "high quality" preferred stock:

(1) has an investment grade Moody's rating (as opposed to a speculative or junk grade rating);

(2) has the "cumulative" dividend requirement, meaning that if the issuing company skips a dividend payment to you they still owe you the money (their obligation to you accumulates); and

(3) is issued by a company that has a perfect track record of never having suspended a preferred stock dividend.

There are seven more criteria that ordinary preferred stocks must meet in order to be considered "high quality" as presented here.

Savers - Bank Certificates of Deposit Performance, 2011

Figure 2 plots the average annual yield provided to savers by bank Certificates of Deposit (CDs) throughout the year.

Bank CD rates are closely related to the federal funds rate so the Fed's policy has pushed CD rates down accordingly. Since the Fed introduced its low-to-no interest rate policy in December 2009, savers have really taken it on the chin.

The average annual yield from bank CDs began the year at 1.53% (24-month certificate) and steadily dropped to finish the year returning 1.19% to account holders, a painful reduction from where they started. Savers who had purchased a CD several years ago that matured during 2011 received a real shock. Nest egg dollars that were earning three or four percent are suddenly going to be generating, at most, half the income that they use to.

To add insult to injury, annual inflation (as measured by the Consumer Price Index) for 2011 is going to come in at about 3.2% (source: inflationdata.com). That means that inflation during the year ate any returns earned by savers by more than twice over.

While the Fed's low-to-no interest rate policy has delivered stable prices and 7.3% returns to those investing in high quality preferred stocks, savers have been decimated.

Common Stock Investors—2011 Performance

As dismal as the 2011 results are for savers, it is not clear that common stock investors did much better once you consider the risk that they are taking.

As illustrated by Figure 3, the S&P 500 common stock index started the year at 1,257.64.

This index of common stock performance ended 2011 at 1,257.60 returning an average appreciation of zero to common stock investors (no preferred stocks are included in this index).

The average annual dividend paid by these common stocks was about 2%. That means that after taking the risk that is inherent with common stock investing, common stock investors did about the same as those who purchased a bank CD at the beginning of 2011.

During the first half of the 20th century the Industrial Age provided the big value driver for American business. And during the second half, it was the Information Age. With the exception of 2003 and 2009, the lack of such a value driver for the 21st century has left value seeking common stock investors empty handed.

The Lost Decade for common stock investors (2000+) just completed its 12th year.

As they have for several years now, the highest quality preferred stocks generated several times the return as that earned by savers or common stock investors throughout 2011.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.