Low Yield Vs. High Yield Preferred Stocks. Is The Spread Wider Than You Thought?

by: Richard Hill

The stock market and preferred stocks have bounced back from the 4th quarter of 2018.

This article will provide one table of preferred stocks with the lowest yields and the second table with the highest yields now available.

The results from analyzing the companies from both tables might surprise you.

My last article ended with a summary of how the market and preferred stocks have done since the end of 2018. I wrote the following:

During the last 3 months of 2018, the market dropped into bear territory. With the scare of rising interest rates, preferreds stocks and other interest sensitive securities fell along with the market. However, 2019 has been a very positive story with many preferreds returning to their previous highs after the fed made it clear that interest rates would stabilize. Even with recent highs, there are still many relatively safe and reliable preferred stocks that are available with high yields.”

Now that the market has rebounded, the yields have changed from December of 2018. While I normally focus on finding safe and reliable yields above 6%, I wanted to find and compare what yields were available at the low end of the yield spectrum and compare to the highest yields. I track over 600 preferred stocks and ETD securities in my database and there are companies from a wide range of industries with low to high-risk levels. The result of my search is to provide 2 tables of securities. One with low risk, low yields and the second with higher risk, high yields. This will allow the investor to see the variety of choices that are available in the marketplace and to determine if any meet their requirements for safety and ability to provide reliable and sustainable dividend payments.

The first table contains the issues with the lowest yields. The second table contains higher yields. The criteria I have selected is: Price less than $25.01 and issues that are either cumulative preferred or ETD securities. Please note that many of these companies have multiple issues, but I limited the list to 1 or 2 in order to keep the article small.

I will also be doing a general review and analysis of the parent company in each table. The review will help determine the overall financial health of the company and whether it has the ability to pay a reliable and sustainable dividend. This review is based on the Where’s the Metrics analysis system that I wrote about here. These metrics include earnings, payout ratios, debt ratios, credit ratings and dividend metrics. We will compare the issue with other companies in the table, but please note that it is best to compare companies in the same industry.

The table shows parent company in the gray row with the preferred stocks and ETD securities located directly under the parent.

The first table shows the low yields that are available:

Low Yield Preferred Stocks

(Courtesy of I Prefer Income)

The parent companies in this table include: Aegon N.V. (AEG), Bank of America (BAC), Entergy Corp. (ETR), Goldman Sachs Group, Inc. (GS), Kansas City Southern (KSU), MetLife, Inc. (MET), Morgan Stanley (MS), SunTrust Banks, Inc. (STI), U.S. Bancorp (USB), Zion Bancorporation (ZION). These 10 parent companies have 12 issues. The average yield is 4.6%.

Earnings: I have placed a red rectangle around each of 5 areas for review. The first area is earnings. The table displays 5 years and 5 quarters of earnings. 8 out of 10 companies report being profitable 5 out of the last 5 years. Those same companies also report 5 out of the last 5 quarters as being profitable.

Payout ratios: The 2nd area for review is payout ratios, including stock, preferred stock, and preferred to operating cash flow payout. Remember that preferred stock dividends cannot be stopped or delayed until the company is in serious financial condition and it has completely cut their common stock dividend. That is a hurdle that we want to pay attention to. Also remember that a score under 1 means that the company is earning enough in GAAP or Non-GAAP earnings to cover the dividend. A score over 1 means that they are not covering the dividend. All companies in the table show scores under 1. Please keep in mind that it is important to have as low a score as possible. The stock dividend score of .97 is much higher than the scores from the other companies.

Debt: The 3rd rectangle shows 3 debt ratios of interest coverage, debt to EBITDA and debt to equity. We want the interest coverage ratio to be over 1 and the other 2 debt ratios to be as small as possible. Each industry is different, but in general, it is best to see a score of under 4 or 5 with debt to equity. I should also point out that many financial companies do not have interest coverage scores because of the nature of their business. They report interest differently than other companies. Since most of the companies in this table are banks, we don’t have many scores to report.

Credit Ratings: The credit rating located in the 4th rectangle are generally high. 8 out of 12 issues are investment grade ratings.

Dividend metrics: The 5th area contains several dividend-related fields of info that are important. The first thing to note is that all parent companies pay a common stock dividend. Remember that the company cannot stop or delay the preferred stock dividends unless the common dividend is cut first. Another metric we follow is the 3-year average yearly dividend growth rate. This shows that all but Aegon N.V. have increased their dividend over the last 3 years. I also track Dividend Diamonds. These are companies that have increased their dividend 5 or more years in a row. It is great to see that 7 out of the 10 companies have increased their common stock dividend 5 or more years, with 2 having the highest scores of 8.

In summary, the companies in the low yield table are lower risk companies. Most of the areas in the Where’s the Metrics analytic system have positive ratings or scores. It is no wonder that the average yield for this group is low. If you wanted to maintain a conservative portfolio of preferred stocks and ETD securities, this would be a good list to pick from.

The 2nd table shows the issues with the highest available yields

High Yield Preferred Stocks

(Courtesy of I Prefer Income) The parent companies in the second table include: Arlington Asset Investment (AI), Compass Diversified (CODI), DCP Midstream (DCP), Dynaglas LNG Partners (DLNG), GasLog Partners (GLOP), NGL Energy (NGL), NuStar Energy (NS), New York Mortgage Trust (NYMT), Pennsylvania Real Estate Trust (PEI), Sotherly Hotels Inc. (SOHO), Seaspan Corp. (SSW), Teekay LNG (TGP). These 12 companies have 17 preferred stocks and 1 ETD in this table. The average for the 18 is 8.7%. That is almost twice the yield from the lowest yields with an average of 4.6%. Now let us take a quick look at these issues using the Where’s the Metrics analytics system.

Earnings: The first earnings metric is much different than what is displayed in the low yield table. This table shows a much more diverse range of earnings. There are 4 out of the 12 companies with 5 years of profits. PEI goes as low as 0 years of profits. Please note that the 2 earning rows are based on GAAP earnings. By looking at the Type Payout row, we see that 11 out of 12 use Non-GAAP earnings or cash flow metrics to determine their ability to cover the dividend.

The difference between GAAP and Non-GAAP earnings/cash flow can be drastic. For example, the I Prefer Income database provides a quick comparison between both. The table below shows the results for Pennsylvania Real Estate Investment Trust. The GAAP record is 0 years of profits and 5 years of losses. By viewing the table below, it is clear that Non-GAAP (AFFO) results are much different: 5 years and 5 quarters of positive results. Don’t be satisfied to obtain only GAAP earnings. In many cases, companies do use and report Non-GAAP earnings.

GAAP vs Non-GAAP earnings

(Courtesy of I Prefer Income)

Payout ratios: It is important to use the Non-GAAP earnings/cash flow to determine common stock dividend payout ratio. All companies report a score of under 1 except for New York Mortgage Trust (NYMP). The preferred stock dividend payout ratios are well under 1, as is the preferred stock dividend to the operating cash flow ratio. Generally, all companies appear to be able to pay their common and preferred stock dividend. Questions do arise with NYMT.

Debt ratios: Debt ratios are not as clear as the payout ratios. I look for scores that are out of line with their peers. In this group, there appear to be out-of-alignment numbers for Pennsylvania Real Estate Investment Trust and NYMT.

Credit Ratings: 14 out of 18 issues are not rated. The other 4 are below investment grade. That makes it clear that investors need to know how to analyze companies they are interested in.

Dividend Metrics: I start the dividend review by noting that all 12 companies do pay a common stock dividend. However, the 3-year dividend growth record is not as encouraging as the low yield table. Most show negative growth, with the exception that 6 show either 0 or positive growth. There are also 2 companies that have earned the Dividend Diamond designation, Sotherly Hotels, Inc. and GasLog Partners LP.

In summary, the high yield table lists 12 companies with 18 issues. The average yield is 8.7%, with the low being 7.9% and the highest yield sporting a 11.3% yield. The risk level is much higher than the low yield companies, but the Where’s the Metrics analysis system does point out many encouraging areas.

To summarize this article, it is easy to recognize why the yields listed in table 1 are so much lower than the yields in table 2. If you are a conservative investor, most of the issues in table 1 provide a good selection of preferred stocks to invest in for longer term positions. At the same time, the higher yields available in table 2 do provide some very encouraging and positive metrics to support an investment. The high yields are nice, but for some investors, they might require more due diligence; and if purchased, should be watched more than the low yield issues. This article does point out the wide spread between the lower risk preferred stocks with low yields and the higher risk companies with higher yields. Each of these 2 could provide one or more of the preferred stocks or ETD securities that meet your requirements. Good luck and thanks for reading.

Disclosure: I am/we are long CODI.PB, DCP.PB, DLNG.PB, GLOP.PB, NGL.PB, NYMTO, PEI.PD, SOHOB, TGP.PB. 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.