Although the interests of preferred and common shareholders are often aligned, it is not always the case, in fact, there are instances when they are diametrically opposed. Furthermore, there are instances when the travails of the common shareholder can actively work to the advantage of his preferred brethren.
This article is designed to explore those instances when the interests of each do not align, and is written from the perspective of the preferred investor. To accomplish this, I'd like to begin by discussing how and why the cumulative preferred investor must view the market from a different perspective than the common shareholder:
- Preferred investors need not be overly concerned with quarterly financial statements and associated conference calls unless there are indications that the company faces an existential threat.
- As long as a company survives, the cumulative preferred shareholder knows that ultimately, his shares will be worth par value, and until they are called, the issuing company must pay the holder the coupon rate. This is different from the effective yield, which was determined by the price the shares they were purchased for. The higher the price, the lower the yield.
- Should the issuing company suffer a bad patch and consequently suspends the cumulative dividend, ultimately those missed payments will have to be fully repaid to the holder as long as the company does not go bankrupt.
- During the time the preferred dividends are suspended, the company will do everything in its power to restore these missed payments as soon as possible. It does this because it suffers under a variety of punitive restrictive covenants as determined by in the issuing prospectus of each preferred, which to varying degrees negatively affects the ability of the company to raise additional capital and operate in a normal fashion.
- As a preferred shareholder, I've always assumed my interests are directly aligned with those of the company insiders. The only way they could hurt me would be by bankrupting the company, and no matter how venal or corrupt they might be, the last thing they would want to do was bankrupt or kill the golden goose. They might steal the golden eggs, but kill the goose laying those eggs, never.
- I recently submitted an article that detailed how, over the past five years, the common shareholders mostly suffered income losses while the preferred shareholders of the same companies profited. For those interested, I have provided the link.
- Ironically, preferreds with suspended dividends gain value the longer the dividends remain suspended, although their low prices will not reflect this fact. However, the moment savvy preferred investors are alerted to the possibility that the existential threat might have been avoided, those preferred shares will rebound with lightning speed, most often exceeding par value relative to the number and amount of missed payments that have accumulated. For example:
- The Baltic Dry Index (BDI) numbers improve and along with it, drybulk shippers' prospects will improve dramatically: Safe Bulkers (NYSE:SB), Navios Maritime Holdings (NYSE:NM), Box Ships (NYSE:TEU). This might also be seen in the event container shipping rates improve: Costamare (NYSE:CMRE), Global Ship Lease (NYSE:GSL), and Navios Maritime Partners (NYSE:NMM) to name a few. Please note at the moment only NM, NMM, and TEU have suspended their preferred dividend payments.
- The troubled company might be taken over or merged with a stronger one as happened when Supertel Hospitality (SPPR) preferred SPPRO became Condor Hospitality (NYSEMKT:CDOR) preferred CDORO. The preferred skyrocketed as I detailed in the following linked article.
- The failing company reports positive earnings results or increased access to credit with the consequence of increased liquidity that might tip the balance away from the possibility of the existential threat.
Conversely, the common shareholder normally views the companies they invest in from a different perspective:
- Even those shareholders who primarily invest in dividend-paying equities, must be attentive to quarterly financial reports and conference calls. Share price movement in either direction impacts them directly and meaningfully.
- Because their dividends are not fixed, they are often dependent upon share price fluctuation. Unfortunately, dividend reductions are more likely to occur when the price of the common share falls, than to rise along with the common share price increases. Some boards make an art of dropping the dividend to match the share price fall in order that the dividend yield remain approximately constant, luring new unwary and not so savvy investors with their promise of attractive dividends.
- Unlike preferreds, common share prices are entirely fluid with no ceiling or guarantee of a call price at par value. Consequently, the common shareholder can make a killing with a successful company, or conversely, never recover from a loss in share price.
- Furthermore, beyond bad press, companies, at any time, can suspend, cut, or eliminate common dividend payments without fear of sanctions or penalties other than the further fall of their shares' value. Missed payments that are neither owed to the shareholder nor are ever meant to be repaid.
- When companies issue additional common shares, in effect they are diluting the value of the current shareholder's shares, often to the negative, yet can be considered a positive for the preferred shareholder because of the funds raised by the company often strengthens the company at the expense of the common shareholder but not the preferred shareholder. Even when new preferreds are offered, the fixed dividend payments of the current preferred shareholders remains unaffected.
- Common shareholders are necessary to each company, but ultimately, their interests are not directly aligned with the company insiders who might milk the company dry, which the common shareholder usually ends up paying for. But not the preferred shareholder; his payments are fixed, and ultimately, must be paid if the company is to survive.
Practical Considerations and Actions taken By This Preferred Investor:
Ironically, the start of this year has closely mirrored that of 2009, when my fortunes changed for the better as it has this year. However, this year, I simply can't begin to understand the sudden and dramatic turnaround from what began as an unmitigated horror to what has thus far become one of my best years in the market. The following charts are a graphic illustration of this:
In the above chart, beginning on February 1, 2009, the S&P 500 began a bull market run that continues today. During that time, although I was terrified by my losses, I understood why the market was recovering. Obama had recently taken office and the government was heavily engaged in stimulating and jump-starting the national economy. Bernanke and the Fed also worked toward this goal and things began to move in the right direction, as did my now burgeoning preferred portfolio, which I added to as my borrowing power grew along with my confidence in the recovery.
This year, beginning on February 11, the S&P 500 climbed off the floor from the worst start of the year that I can recall since 2009, and again began its meteoric rise, as did my portfolio. Thus far, I have replaced an approximate $600,000 loss for an approximate $300,000 gain in less than six months. This time, however, I'm mystified and worried because I don't really understand this 180 degree turnaround. My trepidation has increased along with my feeling that the preferred market, specifically, has become irrationally exuberant.
Most noticeable these past two months as I conducted my three-month updates of companies I have formerly reported on. My linked Five Oaks Investments (NYSE:OAKS) review really sealed the deal for me. As far as I was concerned, the numbers for this company were, in fact, worse than I had reported them initially, yet the price of its preferred, OAKS-A, had increased by $2.49 from $20.07 to $22.56 over the past three months.
I was convinced and as a result, I have accelerated my preferred selling, which is completely out of character for me. I'm selling a number of my preferreds, especially those that were trading above par value. However, to be completely honest, I had several compelling reasons for this action beyond what I have just described:
- I was too leveraged as far as I was concerned during a time when I considered the preferred market might be entering bubble territory because investors were irrationally chasing yield in this low interest rate environment, often disregarding the strength or weakness of the underlying company.
- Being a knowledgeable preferred investor, I realize that preferred prices above par have a limited upside, which naturally triggers my urge to sell. This is not so with commons where no ceiling for profits exists.
- I took advantage of a wonderful opportunity to take tax-free capital gains because they would be offset by the losses I incurred last year with the oil price plunge fiasco.
- I was collecting many more dividends than I required or could spend, and paying taxes in brackets I no longer needed nor wanted to be in.
- I anticipate in the near future that some event like a FOMC tax hike or normal cyclic contraction will hit the preferred market and drop prices back to their normal slightly to moderately sub-par values, which will send me back for a shopping spree, which I hope will net me higher yields at lower risk.
Below are a list of some of the preferreds I recently sold. The companies listed are Tsakos Energy Navigation (NYSE:TNP)*, New York Mortgage Trust (NASDAQ:NYMT), NorthStar Realty Finance (NRF), Ashford Hospitality (NYSE:AHT), Radiant Logistics (NYSEMKT:RLGT), Invesco Mortgage Capital (NYSE:IVR), Newcastle Investment Corp. (NCT), Hersha Hospitality Trust (NYSE:HT)**, Seaspan (NYSE:SSW)**, Kinder Morgan (NYSE:KMI), Adcare Health Systems (ADK), Annaly Capital Management (NYSE:NLY), Lexington ealty Trust (NYSE:LXP), and Dynex Capital (NYSE:DX):
* With TNP, I traded the C for the D, which I believe is a much better buy, although this is a contrarian view.
From the extreme right column inward they are: Number of shares sold, Profit or Loss, date of sale, amount collected, original cost. I used to include the dates of purchase, but I found it to be unnecessary and discontinued the effort.
Disclosure: I am/we are long NM-G, NM-H, GSL-B, TNP-D, NCT-B, SB-D, CMRE-C, CMRE-D, NYMTO.
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.