By Philip van Doorn
This year nearly every type of security has declined — bad news if you look at your portfolio’s value each day and have difficulty sleeping at night. On the other hand, it’s good news if you’re looking for income.
Why is it good news?
Because the rising interest rates mean falling prices for bonds and preferred stocks. For those income-oriented securities, low prices mean higher yields for investors who buy now and possibly — or even probably — higher capital gains down the road.
This year has been brutal for funds that invest in bonds and preferred stocks. But any income investor must expect securities’ market values to move in the opposite direction of interest rates. These instruments are only appropriate for long-term investors who want income. They are not designed for quick gains.
The Invesco Financial Preferred ETF’s /zigman2/quotes/200831949/composite PGF -0.13% share price is down 20% in 2022. It pays a monthly dividend that has oscillated between 7.1 and 7.2 cents a share over the past year. If we go with the 7.1 cents and the closing price of $15.04 on Sept. 28, the current yield for a new investor is 5.66%. At the end of 2021, based on the closing price of $18.82, the current yield was 4.53%.
So PGF has become a more attractive investment. But you might consider holding your own preferred stocks — you can hold them as long as you like and sell them for a gain or a loss, with the former much more likely after prices for older securities have dropped far below face value — provided you have the discipline to hold on for years.
Below is a set of terms and resources, plus two lists of preferred stocks, to provide examples of ways income-seeking investors can take advantage of the current discounts.
Preferred shares of JPMorgan Chase
For example, JPMorgan Chases’s /zigman2/quotes/205971034/composite JPM -1.75% Preferred Stock Series JJ was issued at a par value of $25 in January 2021, at a dividend rate of 4.55%. At the end of 2021, the closing share price was $26.23, which meant if an investor bought the shares at that price, the current yield would be only 4.34%, and if the preferred stock were redeemed, the investor eventually would book a loss of $1.23 a share.
Fast forward to Sept. 28, and the JPM Series JJ had fallen to $19.02 a share. If you went in at that price, your current yield would be 5.98%, and if the shares were eventually redeemed, your gain would be $5.98 a share.
In a note to clients on Sept. 7, Odeon Capital analyst Richard Bove explained that he has a “hold” rating on JPM’s common shares, but recommends buying the company’s preferred shares.
Preferred stock terms
Before showing you where to get the information, here are some definitions of terms you will need for your own research into preferred stocks.
Any investor can buy preferred stocks. All you need is a brokerage account.
A preferred stock is different from a common stock in that its owner has no voting rights. Preferred stockholders also have preference over common stockholders in the event a company is liquidated. To make it simple, if a company goes bankrupt and is liquidated, bondholders are paid first, then preferred shareholders and then common shareholders.
A company may have several preferred stock issues. Investors buy preferred stocks for dividends, just as they would buy bonds for interest income. Preferred dividends are typically paid quarterly.
Par — This is the price at which a preferred stock is issued. It is typically $25 but could be $100 or another price. The par value is similar to the face value of a bond. It is what the investor will be paid if the preferred stock is redeemed by the issuing company. Just as bonds’ market values fluctuate, preferred share prices fluctuate, typically in the opposite direction of interest rates in the economy. In the current environment, with interest rates rising, many preferred stocks are trading at discounts to par.
Premium/discount — The difference between a preferred stock’s current price and the par value.
Coupon — A preferred stock’s stated yield, based on the par value. This is typically a fixed rate, but many large issuers have fixed-to-floating-rate preferred stocks, which might be well-positioned in the current environment. In the lists below we stick with fixed-rate preferreds, for simplicity. A fixed coupon will be included in the preferred issue’s name.
Dividend rate — The stated yield multiplied by the par value. JPMorgan Chase’s Preferred Stock Series JJ was issued on March 10, 2021, at a par value of $25 with a 4.55% coupon. The annual dividend is $1.1375.
Current yield — The annual dividend rate divided by the current market price. JPMorgan Chase’s Preferred Stock Series JJ closed at $19.02 on Sept. 28. That made for a current yield of 5.98%.
Qualified dividends — These are dividends that for U.S. investors are taxed at rates below their regular income-tax rates. For example, a married couple’s federal income tax on qualified dividends zero if their annual income is $83,350 or less, and the rate is 15% if their income is $517,200 or less.
Call date — The date when the issuer may decide whether to redeem the preferred stock. The issuer can redeem some or all of that preferred series any time beginning on this date. If interest rates are significantly lower than they were when the preferred stock was issued, the issuer is likely to redeem. In the current environment, with interest rates having risen so quickly, redemptions are unlikely. But investors who take advantage of today’s discounts will have something to look forward to as they enjoy the high income — the U.S. economy won’t be growing at an accelerated pace forever. Eventually interest rates will come down again and then preferred-stock prices will move up significantly.
Maturity date — The date when the preferred series will be completely redeemed. These days, most preferred stocks are “perpetual,” which means there is no maturity date, although there is typically a call date. JPMorgan Chase’s Preferred Stock Series JJ is a perpetual preferred with a June 1, 2026, call date.