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Should You Buy AT&T’s Preferred Shares Instead of Its Common Stock?

By Leo Sun - Feb 23, 2020 at 11:45AM

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The telco’s preferred stock offers more stable returns with a lower yield.

AT&T's (T 1.27%) stock is generally considered a sound investment for investors looking for stability and income. The giant telecom pays a high forward yield of 5.4%, it's hiked that dividend annually for 35 straight years, and it trades at just 10 times forward earnings. Its massive wireless, wireline, pay-TV, and media businesses also give it a wide moat against its smaller rivals.

However, investors might not realize that AT&T also offers three additional classes of "preferred" shares: series A shares, which were introduced in late 2019; and series B and C shares, which were issued in mid-February. Should investors consider swapping their common shares of AT&T for their preferred counterparts?

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Image source: Getty Images.

Preferred vs. common stock

There are several key differences between preferred and common shares. First, common shares usually have voting rights, but preferred shares don't.

When a company sells a preferred stock, it doesn't dilute its common shares or give up any ownership rights. In that regard, a preferred stock is more similar to a bond, and it generally underperforms the common stock if it rallies but outperforms it if it slumps.

Preferred shares usually offer a "fixed" dividend that isn't raised or reduced. But if a company is struggling, it must pay preferred shareholders their dividends before paying common shareholders. If a company fails, it must pay preferred shareholders a set "liquidation value" for their shares, while common shareholders can get wiped out.

Many preferred shares are also "callable" or "convertible." Callable shares can be "called" by the company, or exchanged for cash, at its discretion. Convertible shares can be converted to a set amount of common shares if certain conditions are met.

What is AT&T offering?

Last December, AT&T issued $1.2 billion in Series A preferred shares. This stock pays a fixed yield of 5% and can be called with a liquidation preference of $25.

In February, it issued 2 billion euros ($2.2 billion) in Series B preferred shares aimed at big investors, with a liquidation preference of 100,000 euros ($107,946) per share. These shares pay rising fixed distributions, which start at 2.9% (based on its current par value), rise to 3.1% in 2025, and then 3.4% in 2030 and 4.1% by 2045.

AT&T also issued $1.75 billion in Series C preferred shares, which pay a 4.75% yield with a liquidation preference of $25. That was an odd move since investors can simply buy the Series A shares for a higher yield.

AT&T is selling all these shares to reduce the debt it accumulated from its acquisitions of AWS-3 spectrum licenses, DirecTV, and Time Warner. In fiscal 2019, AT&T reduced its long-term debt by $20.3 billion to $151 billion, but its debt-to-adjusted EBITDA ratio of 2.5 remains uncomfortably high.

In short, AT&T needs to raise more cash to reduce its debt, but it doesn't want to dilute its own common shares or incur even more debt. Therefore, issuing new classes of preferred shares seems like an ideal solution.

Why investors should stick with the common shares

AT&T's preferred shares offer investors a way to collect the telco's high dividends without fretting over its sluggish wireless growth, weak pay-TV business, and costly efforts to integrate WarnerMedia and unite a fragmented streaming ecosystem. Yet I believe investors should stick with the common shares, for three simple reasons.

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Image source: Getty Images.

First, AT&T's preferred shares pay lower dividends than its common stock. AT&T is a Dividend Aristocrat -- a member of the S&P 500 that's raised its dividend annually for at least 25 years -- and it will likely pay its dividend from its cash reserves instead of slashing its dividend if its payout ratio ever exceeds 100%. Preferred stockholders will miss out on its future dividend hikes as they collect a lower yield.

Second, a lot of pessimism is already baked into AT&T's stock. Investors often overlook the potential catalysts -- including the growth of its OTT services, the divestments of its non-core businesses, and the arrival of 5G devices -- which could all boost the stock to fresh highs over the next few years. Preferred shareholders would miss out on those gains.

Lastly, investors who want stable returns from AT&T can simply buy some of its bonds, many of which offer yields comparable to those of its common and preferred stock.

The bottom line

AT&T's preferred shares are fairly safe investments for conservative investors. However, I think most investors should either stick with AT&T's common stock, which offers a higher yield and more upside potential or shop around for other promising dividend stocks instead.

Leo Sun owns shares of AT&T. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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