With the third quarter of 2014 now behind us, the number of investment grade preferred stocks selling for a market price below $25 is now at 71. While 71 candidates is much lower than the 167 we started the year with, it is still plenty for preferred stock buyers to pick from.
At the end of 2013, preferred stock investors were certain that as the Fed tapered out of its QE bond-buying program, interest rates would go up. After all, when the Fed launched QE with the objective of lowering rates, the program worked so it seemed reasonable that backing out of QE would have the opposite effect.
In anticipation of higher rates, the average market price of preferred stock shares fell to $23.05 as 2013 came to a close, pushing up the number of investment grade candidates that were selling below their par value ($25 in most cases) to 167.
The Preferred Stock Market, Q3/2014
As we now know, the expected rate increase did not materialize as the Fed exited their QE program. The price drop that we saw at the end of last year turned out to be short-lived. Predictably, average preferred stock prices are now about where they were a year or so ago at $25.16 per share.
This Preferred Stock Market Snapshot™ chart depicts the preferred stock marketplace at the end of Q3/2014 (October 24, 2014) along with two characteristics that are usually high on the list of considerations for risk-averse preferred stock investors -- current market price (above and below these securities' $25 par value) and investment risk (as reflected by investment grade versus speculative grade Moody's ratings).
Each diamond represents a preferred stock. The sweet spot of the preferred stock marketplace is depicted in the green lower-left quadrant -- investment grade preferreds selling for a market price below their $25 par value.
While there are currently 914 preferred stocks trading on U.S. stock exchanges, 322 meet the criteria listed under the chart. The arrow in the table below the chart points to the migration that we have seen this year. As prices have increased this year, the percentage of the market occupied by investment grade securities that are priced below $25 has fallen to 22 percent, down from 47 percent at the end of 2013.
(Source: CDx3 Notification Service database, PreferredStockInvesting.com)
Maximum Yield Candidates
The purple diamonds on the above chart identify the four preferred stocks that are offering the maximum current yield from each quadrant (not to be taken as recommendations): TDE, HSEA, MHO-A and GDP-C.
Note that for comparison purposes, I have selected Current Yield (CY) for the Yield column rather than Yield-To-Call (YTC) or Effective Annual Return (EAR) since two of these four securities have exceeded their call dates (YTC and EAR are not able to be calculated in those cases).
TDE is an Exchange-Traded Debt Security (ETDs) introduced by Telephone and Data Systems (NYSE:TDS) in November of 2010, becoming callable on November 15, 2015. TDE's Baa2 rating is two notches into Moody's investment grade rating scale. ETDs are very similar to preferred stocks and are often labeled as such, but they are actually bonds that trade on the stock exchange (rather than the bond market). ETDs offer cumulative dividends and are recorded on the company's books as debt rather than equity. As bonds, ETDs are generally seen as having less investment risk than the same company's preferred stocks (see "Preferred Stock Investors: 'Exchange Traded Debt Securities' Offer Same Reward, Lower Risk", March 20, 2012). At 6.96 percent, TDE has the highest current yield of today's investment grade securities that are trading below their $25 par values.
HSEA is a trust preferred stock (TRUPS) introduced by Britain's largest bank, HSBC Holdings PLC (NYSE:HSBC), at 8.125 percent in April 2008 and has been callable since April 15, 2013. Note that HSEA offers Qualified Dividend Income (QDI) to individual investors (but not to corporate investors since HSBC is a foreign company). As a TRUPS, HSEA provides cumulative dividends but today's buyers should be sure to read the prospectus of this security since the issuer, at their option and at any time, is able to convert these cumulative HSEA shares into non-cumulative "dollar preference shares." Today's buyers may also have to find a way to overlook the $1.92 billion fine that HSBC was required to pay in late-2012 for providing illegal banking services to the world's drug cartels (see "Bleak day for British banking as Libor arrests follow record fine for HSBC", The Guardian, December 11, 2012) and the bank's role in the LIBOR manipulation scandal more recently. Today's $26.24 market price exposes buyers to a $1.24 capital loss in the event of a redemption of HSEA shares.
MHO-A is a traditional preferred stock introduced in March 2007 at 9.75 percent by M/I Homes, Inc. (NYSE:MHO). M/I Homes was founded in 1973 and develops single family homes throughout the United States. At Caa1, MHO-A is well into Moody's speculative grade rating scale which explains the 9.57 percent current yield for this security. Shareholders were caught short during the summer of 2008 when the company suspended the dividends on these non-cumulative shares. Dividend payments were resumed in June 2013. Trading at $25.47, today's buyers are exposed to a $0.47 per share capital loss in the event of a redemption (MHO-A became callable on April 10, 2013).
GDP-C is a traditional preferred stock offering cumulative dividends and was introduced in April 2013 by Goodrich Petroleum (NYSEMKT:GDP) at 10.0 percent. Its Caa2 rating is so low that this security is barely hanging onto the low end of the Moody's scale. The early-October plunge in global oil prices showed up quickly in the market prices for energy-related securities. GDP-C started October at $26.30 per share but dropped as low as $18.51 on October 13. The more risk-tolerant among us might consider GDP-C as a capital gain opportunity, assuming that those in charge of manipulating global oil prices are able to push prices back up. Note too that GDP-C is a QDI-designated security.
These four securities from four vastly different companies are offering the maximum current yields in the four key quadrants depicted by the Preferred Stock Market Snapshot™ chart.
A strong retail sales report on September 11 pushed preferred stock prices lower for the second consecutive month -- the first two-month drop this year. The implication was that if retail sales are picking up, inflation cannot be far behind so the Fed will surely be bumping up rates any time now.
But when global oil prices fell during early October, speculators had the opposite reaction -- lower fuel costs drive prices down, which is sure to postpone any thoughts the Fed may have about raising rates.
Those reacting to such events are applying the short-term thinking of a value investor (buy low, sell high) to a long-term income investment (preferred stocks), which often creates buying opportunities for preferred stock investors who are paying attention.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The CDx3 Notification Service is my preferred stock email alert and research newsletter service and includes the database of all preferred stocks used for this article.