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TIP Academy
LESSON SUMMARY
In this lesson, you learn how to value a preferred stock. The final metric you are looking for after doing the calculation of the value is called the “yield to maturity”. This is really just a fancy way of saying: What return can I expect to get from the preferred share assuming that the company that has issued it doesn’t go bankrupt? The lesson also answers the following questions:
1) Where is the best place to conduct research about a stock: The best site is the free site Quantum Online. It provides you with a simple overview of the coupon rate, call price and all other relevant information about preferred stock you can think of.
2) Why is the call date important: Just like a bond, many preferred stocks have a given term when it expires; however, it’s not uncommon that you will find a preferred stock that doesn’t have a call date. What this means is that the management in theory can defer the payment indefinitely. While this is a drawback, it’s not plausible that the company wants to do so, since it can’t pay out dividend to the common stock holders in the meantime.
LESSON TRANSCRIPT
First of all, know that you will need to refer to the video to fully understand what’s written here.
On the left side of the video is the website quantumonline.com. On the right side is the buffettsbooks.com website.
WHERE YOU CAN RESEARCH ABOUT PREFERRED STOCK
Quantum Online is probably the best website to conduct research on preferred stocks. Everything under this is free. I recommend you sign up for an account because you’ll have full access to all their different search results in different preferred shares and access to the site. Once you sign up for an account like mine, go to the income table. Click and select All Preferred Stock. It gives you pages of lists of all these preferred stocks that you can invest in. this is definitely the most comprehensive spot to find something that deals with preferred stocks. An online search looking at a preferred stock only comes up with nothing but unorganized information scattered. Quantum Online really has organized information.
We’ll start from left to right. At the very top, you have the symbol, the security itself, the date that the security was introduced which is the IPOD, the coupon rate, the annual amount you’d be paid off for a dividend, the coupon rate, the dividend rate, the call price, the preferred stock that could be called at, the day for the call, the maturity date, the Moody’s ratings, and the S&P ratings. This is very useful when looking at preferred shares because they often have a little bit of debt and sometimes don’t display the best financial decisions for the company that you’d be investing in. It tells you whether it’s a 15% tax rate or not. When you buy that, it has the full perspective where you can go ahead and pull off all the detailed information about a specific preferred stock. Last is the distribution dates – the very first one we’re looking at here.
It says suspended. That means the coupon or the dividend that this preferred stock was paying is longer paying that. It gives you all the really important information all in one line for our preferred stock. You’re going to be hard-pressed to find this type of information consolidated in one place. This is one reason I’m a huge proponent of Quantum Online.
One of the nice things about this website is at the top, if you want to filter all these preferred stocks based on the description, you can click security subscription. It puts the most appetizing ones at the top and the least durable at the bottom based off on that description. A high yield and accumulative preferred share at the top like this one are what we see here. Avoid something that has suspended dividend payment.
The call date is important. When looking for preferred stock, you want to have a longer call day as opposed to a shorter one, because if the call date is tomorrow and it’s a very high-yielding preferred stock, the company will buy those. They don’t have to pay that high dividend. The longer the call date is, the longer you have to hold that preferred stock the better.
Now, click on call date to pull up all of this security based on the longest yielding call dates. The call dates keep in the next pages keep decreasing. On this first, Simon Property Group has 8 3/8% yields on the dividend. This is cumulative preferred stock, which is good. The call date is 2027. It’s 2012 now. You have approximately 15 years before you have the company’s ability to start buying these preferred shares back. That’s a good thing if you’re buying this especially because it’s yielding high at 8.38%.
How powerful is this website to sort all these different preferred shares? Everything is all available on that one screen capture. To take a closer look at Simon Property Group, open it in another window. If you’re going to buy this preferred stock, this gives you all the information and all the details that you need to know.
FINDING THE ESSENTIAL ELEMENTS
Where can you find the essential information? First, look forward to a cumulative preferred stock. This means the company pays a dividend of 8.38%. If the company is running into some rough times and they don’t want to pay, they can withhold the dividend payment under a cumulative preferred, but when they don’t have enough money, they have to make up all the payments that they missed before they can pay anyone in the common. You’re eventually going to get your money especially if you hold it to the call date or the maturity date. You really want to avoid non-cumulative preferred.
The call date. The call date on the security is 2022 – 10 years from now before you own that preferred stock, and before it could be called back by what could be when they pay you. The rate they’ll pay you would be this call price of $25. If they were going to buy the preferred share back on you on that date, they would pay $25. The maturity date is typically when you’d receive the call price or the Par value of a bond.
You should know how much a debt the company has. Here are Moody’s and S&P’s ratings to give you a quick idea of the capability of the company to fulfill those payments. An A- proves the ability to meet their debt obligations. However, if the company falls on hard times, it would be stopped in a split second because it’s a non-cumulative preferred share. If you want to dig deep, look at the Wachovia common shares – its debt to equity ratio, current ratio, etc. – and assess the health of the company.
If quantum online pulls up all the information you see now on the video specifically for security, you may call their point of contact, Alice Lehman. Ask her any questions you want about this preferred share.
Let’s go ahead and use Buffett’s Books Yield to Call Calculator to understand this lesson more. The company wants to purchase those preferred shares because they don’t want to continue paying an 8% interest rate. To do this, decide which method to use. For me, I always look at the yield.
Now, I’ll show you a search tool on this website. Go up to the top and look up SPG-J. The preferred shares listed on the New York stocks exchange have a coupon rate of 8.3% because it pays a dividend of $4.18 every year. This preferred shared will be bought back from you. They’ll pay $50. The call date on this is 2027, so we have approximately 15 years before this preferred share gets called back. It has no maturity date; beware of things like this! The premium depends on the interest rates. The value of the preferred share and the value of a bond decreases as interest rates increase and vice versa. With a low interest rate, this is the right time to look for shares or bonds. If you need short-term, this is something to look at.
Let’s plug this in our calculator. Our annual dividend payment is $4.18. The call value is $50. Remember, no dollar sign or percent signs; just put in the raw numbers. Put 15 for the length of years of the call to date. Put in 15, but if you really want to do an accurate move, you have to estimate. For now, we’ll just put in 15. Here, we don’t see what these preferred stocks are currently trading for. Figure out by clicking over on to the New York stocks exchange chart. As we pull up, this is the information and you can see how this preferred share has been trading. It’s at $69.50 now.
Let’s go ahead and plug that in as our market price. When it says the coupon rate is 8.38%, that doesn’t mean you’ll be 8.38%. That just means that you could buy it at the original price that they issued it at which was $50. You would get that 8.38% until the preferred share would be called or you just continue receiving that forever since it has no maturity date.
That’s not the case here. This preferred share is for $69.50 if you buy it today. That return is going to be different than what this calculator’s doing. It figuring it out based on the assumption that his company is going to purchase these shares at that call date. Hit calculate and see that the yield to call is 4.832%. That’s a significant difference. The person that would go can say this preferred share is a cumulative preferred, which is good. However, again, that’s not the case at all, because you’re such a large premium. You’re paying almost $70 to buy this stock when it’s only callable at 50. That’s why your yield to call is much lower to 8.38. You’re seeing 4.832% now. That’s the thing that you really got to focus on when buying preferred shares. You might be better off buying a bond which is more secure than the preferred share, plus it pays a higher return! Buying a corporate bond is less risk. Consider these when you start looking at preferred shares.
It will take time, but if you go back and rewatch this video and go to quantum online, you will understand better.
LESSON VOCABULARY
Prospectus
A detailed document meeting the requirement of the SEC, disclosing all terms that a preferred share is offering potential investors.
Yield to Call
Often simply referred to as YTC, and is an estimate of the return the investor will receive from the respective preferred share from today and until it matures. It is a very used measure to compare preferred shares.
