"High quality" preferred stocks are those that have specific risk-lowering characteristics such as investment-grade ratings and cumulative dividends (i.e., if the issuing company misses a dividend payment to you, it still owes you the money -- see "Selecting the Highest-Quality Preferred Stocks" for more on the subject).
This Preferred Stock Market Snapshot chart depicts the preferred-stock marketplace at the end of the third quarter of 2013 (Oct. 2, 2013). The chart depicts today's marketplace using two characteristics that are important to 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).
While there are currently 948 preferred stocks trading on U.S. stock exchanges, 334 meet the criteria listed under the chart. The lower left quadrant (green) is the sweet spot -- investment-grade preferreds selling for a market price below $25 per share.
Notice how the distribution of preferred stocks has changed over the last year as rates have become more generous and prices have fallen back toward normal. There are now 152 investment-grade issues below $25 to choose from, up from a mere 25 issues a year ago.
Avoiding the perpetual ownership trap
While lower purchase prices are always welcome, preferred stock buyers need to avoid the "perpetual ownership trap" where you purchase shares of a low-paying preferred stock that 1) you can never sell without a capital loss and 2) the issuing company is never motivated to redeem (also known as a "call").
After all, in the event of a call, you will receive the par value (usually $25 per share) in cash in exchange for your shares. Savvy preferred-stock investors seek to purchase shares that are priced below the $25 par value and also offer a dividend rate that is high enough that the issuing company would prefer to redeem the shares downstream.
Likelihood of a call
Historically, dividend rates offered by high-quality preferred stocks range from 6% to 9%. Those offering a dividend rate of at least 6.5% (0.5% above the bottom of the rate barrel) are almost always ultimately redeemed by their issuing company. In fact, there have only been two exceptions since January 2001.
Lower-yielding stocks (below 6.5%) are less likely to be called than high-yielders. So avoiding the perpetual ownership trap is a simple matter of resisting the temptation to purchase low-dividend stocks, even when the price looks spectacular. Limiting your purchases to higher-yielding stocks (at least 6.5%) priced below $25 per share turns the issuing company of your preferred-stock shares into your "built-in buyer," helping to keep you out of the perpetual ownership trap.
Examples of $25 preferred stocks
The purple diamonds on the above chart provide examples (not to be taken as recommendations) of preferred stocks from each quadrant, all of which are trading very near $25 per share. The dividend rate (coupon) offered by each is also indicated.
KIM-H is from shopping center REIT Kimco Realty (NYSE: KIM ) . KIM-H is trading in the sweet-spot just below its $25 par value (October 2, 2013 prices). KIM-H offers a 6.9% dividend and boasts a Baa2 Moody's rating (two notches into the investment grade category). With revenues up 17.8% over last year and a profit margin of 27.17%, the company's operating cash flow (out of which preferred stock dividends are paid) is approaching $0.5 billion dollars (ending June 30, 2013). KIM-H does not become callable until August 30, 2015.
Public Storage (NYSE: PSA ) is the undisputed global leader of the self-storage segment. The company is the highest-rated U.S. property REIT, earning an "A3" Moody's rating. The company's operating cash flow of $1.35 billion is impressive, equal to 75% of its annual revenue. And its 3.27 current ratio -- which means the company could pay all of its liabilities more than three times over by liquidating its assets -- supports the "A3" rating. Public Storage issued PSA-Q in April 2011. The advantage that comes with such a strong rating can be seen by comparing PSA-Q to KIM-H, rated "Baa2." PSA-Q offers a lower dividend (6.5%) than KIM-H (6.9%) but typically commands a higher market price.
DFT-A is one of two preferred stocks offered by DuPont Fabros Technology (NYSE: DFT ) . DuPont Fabros develops corporate data centers -- highly specialized buildings used to house mission-critical computer equipment. Missing an investment-grade rating by two notches at "Ba2," the company has had to boost the dividend offered by DFT-A to 7.875% in order to command a $25 market price. DuPont Fabros has had a solid 12 months, turning much of its 10.7% revenue gain over the same quarter last year into a 106% increase in net operating cash flow.
Goodrich Petroleum (NASDAQOTH: GDPM ) is a $1 billion oil and gas exploration and development company. Goodrich introduced two new preferred-stock issues this year, the Series C (GDP-C) at 10% and, more recently, the Series D (GDP-D) at 9.75%. Due to negative earnings for several consecutive quarters and indications that the company is struggling to meet its cash needs, analysts are generally negative with respect to Goodrich's common stock. The company's preferred stocks are among the lowest-rated preferred stocks trading on U.S. stock exchanges, almost falling off the bottom of the Moody's speculative-grade scale at "Caa2."
The bottom line
Today's preferred-stock market has substantially improved when compared to last year, providing 152 investment-grade preferred stocks available for less than $25 per share to pick from. Limiting your purchases to the highest-quality issues that offer the highest dividend rates, yet are priced below $25 per share, not only adds a layer of principal protection (and positions you for a capital gain in the event of a call downstream), but also helps you avoid the perpetual ownership trap.
While preferred stocks offer a lower-risk alternative to dividend-paying common stocks, picking the right dividend-paying common stocks can make you rich if you are willing to take that risk. And over the long term, the compounding effect of the quarterly payouts, as well as their growth, adds up faster than most investors imagine. With this in mind, our analysts sat down to identify nine rock-solid dividend stocks in this free report. To discover the identities of these companies before the rest of the market catches on, you can download this valuable free report by simply clicking here now.