2019 has gotten off to a great start for marijuana stocks. After a tough 2018, investors are excited about new prospects for cannabis companies, including the recent legalization of hemp production in the U.S. and the ongoing trend toward more jurisdictions making medical and recreational marijuana use legal. Companies in the budding industry have moved aggressively to raise cash, going public and increasingly moving to list their shares on U.S. exchanges in order to gain greater exposure and access to capital.
Some investors are interested in investing in cannabis but don't want the full volatility that accompanies a regular stock investment. With the industry still in its infancy, investment options are still somewhat limited. But there is one way that at least one well-regarded cannabis-related company allows more conservative investors to participate in the marijuana boom -- through investing in preferred stock. It's possible that others will follow suit over time by issuing preferred stock of their own.
The basics of preferred stock
Most of the time, when investors buy stock, they're actually investing in what's called common stock. These shares give shareholders basic ownership rights in the company, but they don't come with any preferential treatment when it comes to rights to distributions or assets if the company liquidates. Instead, if the company has issued bonds, then bondholders have higher priority over company assets in the event of a liquidation, with common shareholders getting anything that's left after bondholders have gotten paid.
Preferred stock is a different type of stock that includes some additional limited rights that common shares lack. In particular, preferred shareholders often get their capital back first before common shareholders receive payments. More importantly, preferred stock almost always pays a healthy dividend, and investors who own preferred stock typically have the right to receive those dividends before common shareholders receive a penny in dividend payments.
Those features make preferred stock a more conservative investment than common stock. As it happens, preferred stock also typically comes with a higher dividend yield.
The preferred marijuana stock with an 8% yield
It's rare enough for marijuana stocks to pay a dividend at all. Income investors are already familiar with Innovative Industrial Properties (NYSE:IIPR), which is a real estate investment trust that owns and leases out properties that cannabis cultivators use in their businesses to grow medical marijuana. Because Innovative Industrial is a REIT, it has to make dividend payments on its common shares of at least 90% of its net income, and recent dividend increases have taken its yield up to an impressive 2.5%.
Yet what many investors don't know is that Innovative Industrial also offers preferred stock. These shares have a par value of $25 per share, and they pay a dividend of 9% of that par value. That works out to $0.5625 per share on a quarterly basis, and based on the preferred stock's current price around $28, that equates to an 8% dividend yield.
The pros and cons of preferred stock
That might sound like a steal, but it comes with a catch. Preferred stock often has provisions under which the issuing company can redeem the shares at a fixed price. That limits both the potential upside on the shares and the length of time that you'll be able to count on getting that premium dividend.
The Innovative Industrial preferred shares are a good example. The issue allows the marijuana REIT to call the shares at $25 in October 2022. So if you pay $28 per share now but then have to accept just $25 when the REIT redeems the preferred stock, you'll end up losing $3 per share -- or more than five quarters' worth of dividend payments. That reduces your effective yield.
In addition, the dividends that Innovative Industrial's preferred stock pays out aren't considered qualified dividends for purposes of applying lower tax rates. Investors will pay the full ordinary-income tax rate on the income they get from the preferred stock.
For many investors, the extra dividend income is worth the downsides of owning preferred stock. It all depends on what your investing priorities are.
Keep an eye out for preferred stock
To be clear, preferred stock is still a risky investment, especially in a highly speculative area like the cannabis industry. If a company fails, preferred shareholders can suffer total losses. Conversely, if a company sees great success, then investors would've been far better off owning common shares than accepting the limited upside of preferred stock.
Nevertheless, many see preferred stock as a good way to get more income from their investments. As the cannabis industry evolves, it's likely that more companies will look at preferred stock as a way to raise capital from those who prioritize dividend income in their investing strategies.