Confessions Of A Preferred Equity Investor

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Includes: AHT, NRE, NRF, NSAM
by: Norman Roberts

Summary

The interests of preferred investors often conflict with those of common shareholders.

Conflicts of interests are easily explained yet rarely discussed by SA contributors.

Why preferred investors should welcome general market volatility.

Why preferred investing is unappreciated and not fully taken advantage of.

To be a successful preferred investor, it's necessary to begin to view the market and individual companies from an entirely different perspective. What you have always considered good might no longer be necessarily so. Conversely, what might be considered bad for the common shareholder, the preferred shareholder might, on occasion, consider good. General market volatility and the dreaded market correction might not necessarily be the time to exit the market, but might be viewed as the opportune moment to begin buying.

The long-term cumulative preferred investor that actually understands the intricacies of preferred investing, realizes that the only way he can ultimately lose is if the issuing company goes bankrupt or the particular investor, for a variety of reasons, might be forced to sell his position. I have detailed this at length in a previous article, which I urge all prospective preferred investors read and pay careful attention to. A number of these reasons are excerpted:

  • Investors who are heavily leveraged and margin-called, thereby forced to sell, or have their positions liquidated; most probably at the worst time when prices are severely depressed.
  • Panic selling when the contracting market fall seems as if will never end or the individual company's preferred share price continues to fall, giving rise to the fear of a potential bankruptcy.
  • The investor finds himself in need of ready funds to pay unexpected or upcoming bills and is forced to liquidate a portion in his portfolio to cover those expenses.
  • When the investor finally sells, accepting the loss after he's suffered emotional exhaustion as a result of the continued and agonizing share price drop, and/or after a time, he's decided the issuing company recovery still remains uncertain, and he is simply no longer prepared to wait for something, he feels, might never occur.

Consequently, short-term individual stock price, and market gyrations, need not necessarily overly interest the preferred investor, except for the possibility of acquiring positions at favorable prices and equally favorable yields. Furthermore, as a rule, general market volatility is the best time to go bargain hunting, because the company (whose preferreds you are interested in obtaining) as a viable entity is in no way affected by said volatility except for possibly the short-term preferred and common share prices. Although I can't predict a complete rebound of the common share price, I can assure you that the preferred shares, sooner or later, will rebound to a price close to their issue price when the general market settles and/or the particular company fortunes begin to stabilize. Of course, this might never occur and the company might go bankrupt, which is always a possibility requiring extreme due diligence before taking the plunge. Knowledgeable preferred investors are usually yield sensitive and eager to purchase depressed priced preferreds sporting abnormally high yields. Additionally, because of the usual limited number of preferred shares available, prices often go up as rapidly as they declined.

For as long as I've been in the market, I have been an SA member, and until recently a viewer rather than a contributor. I noticed that most contributors are knowledgeable, much more so than I; however, the vast majority of their articles are written from the perspective of the common rather that the preferred shareholder. For the most part, they write about the short and medium term price gyrations rather than the long-term viability of a company. I have no problem with this because to be able to do that accurately, they would need a crystal ball, enabling them to peer into the future, which is considerably more than the investor should have a right to expect. Furthermore, most articles concerned with dividends are written from the perspective of the common shareholder, concerning whether or not they are sustainable or will be reduced or cut in the short-term. During this time, and especially when a company is apparently facing existential threat, the possibility of preferred dividend suspensions are often discussed. However, from the perspective of a long-term preferred investor, it might be viewed, and acted upon, differently.

The main purpose and intent of this article is to demonstrate the possibility that the savvy preferred investor must view these articles from an entirely different perspective. I stress this because, often what is perceived as good or bad for the common shareholder perspective is not necessarily the same for the preferred shareholder, as detailed below:

  • The board decided to issue millions of additional common shares, which effectively dilutes the existing common shareholder's position. If dividends are distributed, each common shareholder will now receive a smaller slice of the pie, and consequently, the potential for a dividend reduction.
  • The preferred shareholder's dividend is unaffected, it's fixed. Even in the event of bankruptcy he stands in front of the common shareholder. Additionally, the funds earned by the new share sale might strengthen the company along with preferred shareholder's position.
  • The board decides to cut or suspend the common shareholder's dividend. Bad for the common shareholder, good for the preferred shareholder who now realizes the company has additional funds to continue making the preferred payments; which might also be suspended, but if they are cumulative, they are still owed and must be repaid in full before the common shareholder can begin collecting dividends again.
  • When a sound company's common share price is hit by market volatility, it is short-term bad for the common shareholder, yet possibly good for the preferred shareholder, who, as mentioned above, might decide to go on a shopping spree.

A prime example of the above is displayed in two recent SA articles concerning Ashford Hospitality Trust (NYSE:AHT), which I'd like to call to your attention. Both contributors are correct from their point of view, yet from the perspective of the preferred and common shareholder they might deliver entirely different messages. The first is by a contributor who apparently is quite knowledgeable, and from my perspective knows a whole lot more than I do, especially when drilling down into the company financial numbers. Consequently, I acknowledge that I'm certainly not qualified to critique or even dispute his findings, which are most probably correct, as displayed in Article I. The second, Article II, I've written from the preferred investor's perspective. Although I believe both articles paint an accurate picture, beauty is in the eye of the beholder. My point being: The investment interests of the common and preferred shareholders do not always necessarily align, and on occasion, what is bad for one might be good for the other, consequently, an opportune moment for favorable trades from the preferred investor's perspective. Warren Buffett always claimed that he ran toward the market while others were running away. On occasion, and with more regularity, this might also be true for the preferred investor, who during moments when his common shareholder brothers are rightly exiting their positions, he might be expanding his preferred positions.

In the near future, I shall be writing about NorthStar Realty Finance (NYSE:NRF), NorthStar Realty Europe (NYSE:NRE), and NorthStar Asset Management (NYSE:NSAM), much has been recently written about, but this time from a preferred investor's perspective. In my opinion, the story is much the same as I have detailed with AHT. What's good for the common goose is certainly not the same for the preferred gander. Where the goose might be cooked, the gander might have simply taken wing.

The point of this exercise is to note that a very tiny part of overall market concerns itself with reporting on, and from the perspective of the preferred equity investor. That's principally because preferred equities are traded thinly, and consequently, inadequately covered, reported on, or understood by more than a few investors, including even many knowledgeable SA members, as I've noticed by comments and questions I've had the pleasure of responding to. Consequently, it is my belief that this wonderful source of relatively safe and stable fixed income has not been fully appreciated or taken advantage of by the average dividend investor, which is the reason for this and the majority of articles I have and will continue to contribute.

Disclosure: I am/we are long AHT-D, AHT-E, NRF-B, NRF-C, NRF-D, NRF-E.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.