To many individuals preferred shares are an obscure investment which they know little about. However with a little research you will discover that they are a great alternative to a fixed income mutual fund. Preferred share are shares who are usually issued at $25 and pay a fixed dividend per share per year. Preferred shareholders have preference over common shareholders in dividend payments, as well preferred share holders are paid out first if a company goes bankrupt before the common shareholders. This results in preferred shares being a very safe investment like bonds. Furthermore like bonds preferred shares mature and are redeemed like bonds at their issue price of $25. In the past few months Canadian bank stocks have fallen with the sub prime issues in the the US spilling to Canada. These events has misguided Canadian retail investors to sell preferred shares. In combination with the light volume on preferred shares many issues fell dramatically causing many of them to sell at steep discounts to their redemption price.
These are my current picks for 2008:
Note: To calculate yield to maturity you can use the following online calculator http://www.moneychimp.com/calculator/bond_yield_calculator.htm
Further more not all preferred shares with a high yield are good investments. Preferred shares from chartered banks have virtually no risk, however when buying preferred shares of other companies analysis of their credit rating and financial statements is required.
1) George Weston Limited (Which is the parent company of Loblaws) Series E (TSX:WN.PR.E) is now a Buy at $15.25 per share is currently boosting a yield-to-maturity of 13.785%
2) Laurentian Bank of Canada Series 10 (TSX:LB.PR.E) is now a Buy at $20.00 per share is currently boosting a yield-to-maturity of 10.608%
3) Canadian Imperial Bank Of Commerce Series 32 (TSX:CM.PR.J) is now a Buy at $18.50 per share is currently boosting a yield-to-maturity of 9.807%
4) National Bank of Canada Series 16 (TSX:NA.PR.L) is now a Buy at $20.70 per share is currently boosting a yield-to-maturity of 8.644%
Another important feature of preferred shares is the fact that they pay out dividend and not interest income. So for an individual in the highest tax bracket you multiply the the current yield-to-maturity buy 1.3x to get the interest-equivalent-yield-to-maturity of 17.92% for WN.PR.E.
Note: The preferred shares mentioned above are perpetuals, meaning that redemption is not guaranteed. Over the last 30 years we’ve been in a declining rate environment, those decreasing yields made made the redemption of preferred shares quite probable since the firm would be able to recall them and issue new shares with lower yields. However in a rising rate environment we will most likely not see the same phenomenon occurring (especially when we consider when we are experiencing historically very low interest rates). This leads to the risk that the preferred shares will never be redeemed which is a large risk. All calculations assume shares are redeemed at original par of $25, at the beginning of the furthest call date possible.
I enjoyed your article on preferred shares. I find it difficult to determine whether or not a preferred is perpetual or non perpetual with general search engines. Any websites / search engines you recommend?
Dave
There are 2 ways:
1) The easiest way to find out if a preferred share is perpetual is to visit http://www.prefinfo.com. This site run by James Hymas provides a good database of information.
2) The second method is to visit http://www.Sedar.com and do a search for the prospectus of the preferred share in question. The prospectus will indicate the details regarding the shares in issue.
Tarik
I would be interested in what you think of preferred shares currently – the yields are very high! My concern is about inflation in the longer term and higher interest rates. In your article you mentioned the “large risk” of the shares never being redeemed. I would be interested in your opinion on that risk today?
Thanks
Good question Sharon – I don’t have an answer, but I certainly have an opinion. I’m not sure I see the point of the “never-be-redeemed” risk – it’s not pivotal as an investment decision in my mind. The coupon rate vs market rates are priced into the discount/premium that these things trade at from time-to-time. Redemptions can happen – but there’s no free lunch in any investment avenue. The payoff can improved tax-efficient returns and/or lower risks than other investments.
Canadian bank preferred shares are a fabulous vehicle to derive much better returns than any interest paying instrument (GICS, bonds, etc) at a much lower volatility (risk) than common stock. It is inconceivable that a Cdn bank would fail to pay preferred dividends – but the risk of reduced common share dividends (although still very rare) is much greater and common shares in equivalent institutions generally present greater risk of capital gain/loss.
I think Canadian bank preferreds are a ripping bargain right now – CIBC and Royal issues can be bought to pay 7% or better. Why these things are at such high yield is a bit of a mystery to me, but these are strange times….
Hello,
Because preferred shares (most of the time) are structured as perpetuals there is no obligation for the corporation issuing preferred shares to redeem them in the future.
If we ever enter a secular bull market in interest rates, preferred shares will be hit the hardest out of all debt-based instruments, due to the fact that they have an infinite maturity date (Hence they have to be discounted to infinity).
Consider the following example: From the highs in the late 1960’s to the lows in January 1980, long term corporate bonds fell by over 60% as interest rates rose from 3% to 18%. As the prices and yields of preferred shares closely follow long-term corporate bonds, we should expect preferred shares to perform similarly to long-term corporate bonds in the future.
In such a scenario, preferred shares would be hit even harder than long-term corporate bonds because there would be no intensive for firms to redeem preferred shares, as they would have to roll over the debt to higher interest rates. This will cause the Present Value of principal amount of the share to go to zero, unlike bonds.
If your goal is to protect your money while investing in preferred shares, you should look into floating cumulative preferred shares of Investment Grade companies, these preferred shares will move with interest rates, hence protecting your initial principal of your investment. While you might be getting a smaller yield, your principal is better protected whether we enter a deflationary of inflationary environment.
Go to http://www.prefinfo.com/
Search for “Floating” Preferred shares which and you will find a couple dozen of them. Note most listed floating preferred shares are currently not floating but have dates in the future where they will start floating.
Cheers,
Tarik
Hi Tarik: What do you think about the recent floating preferreds from Great West Life, Power Corp and Royal bank which renew every 5 years at G of C 5 year rate plus 3-3.5% ?
Gerry
Secondly, how would we go about buying, say, the Royal Bank preferred share issue?
I know in the olden days when every offering was massively oversubscribed, it was impossible for the little guy to get in on this, but would the same be true today?
I’m guessing the institutional investors are _not_ going to be buying like they used to, but individuals might have some change they might want to throw at something like this.
Any tips (for someone that has never made a share purchase ever) ?
Hi Tarik:
It is excellent ifo on the Preferred Shares.
I checked on these shares and I found the Yield a lot lower than you have indicated( actually now suppose to be higher becuase the prices are lower). All the 4 shares NOW are lower in price than you have wrote above, and your yield is higher then it is now.
Would you be kind enough to check the Yield .
Thanks
Best regards
Eric
Hello there,
This is my first time investing, and i would like some advice on which stock i should buy. I am interested in RBC, TD, BMO, Scotia, and CIBC. I would like to buy shares that give me a guarantee return, and that i can sell them at any time for the whatever the market price is at the time. I am confuse with the whole perpetual thing. Does this mean that if i buy perpetual bank stock i have to sell my stock at the end of the period? I would appreciate any suggestions you might have. Thanks
Chris