Stupid question time: How to buy a "Preferred" share?

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Stupid question time: How to buy a "Preferred" share?

Post by kombat »

Hey guys,

I know this is probably a dumb question, but nevertheless, I'm relatively new to this.

I would like to buy some "preferred" shares of Canadian banks. Let's say, specifically, RBC. I wish to do this within my RRSP, which is in my TD Waterhouse brokerage account.

So I log into my TD Waterhouse account, and go to the "Buy Order" screen. How the heck to I find/specify the "preferred" shares of RBC? Is it a particular stock ticker symbol? And is there a way for me to specify that dividends be automatically used to purchase more of the same "preferred" shares?

Thanks for any guidance.
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Re: Stupid question time: How to buy a "Preferred" share?

Post by Descartes »

It is a specific stock ticker; for example, RY.PR.C is the ticker for the series C preferred share for RBC.
Mr. Hymas, as always, is a valuable resource: here you can find a list of popular preferreds by ticker.
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Re: Stupid question time: How to buy a "Preferred" share?

Post by Jaunty »

Yes, each preferred has its own symbol. At BMO OL and iScotia, they would be entered as RY.PR.A or RY.PR.B where RY is the company (bank) PR is preferred and the final letter indicates the particular preferred/series you wish to purchase. I have one program that uses commas in the place of some of the periods. I don't use TD Waterhouse so I don't know if the periods will do the trick. Maybe you could go into their stock quote screen and enter it the way I do and see if you get a quote (or just call them!).
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Re: Stupid question time: How to buy a "Preferred" share?

Post by Nemo2 »

Descartes wrote: Mr. Hymas, as always, is a valuable resource: here you can find a list of popular preferreds by ticker.
We've also found that the ~$30 spent for a one month's e-mailed copy of his newsletter recommendations is well worth the expenditure......if you buy one/some of the choices.

(One example, that we've held for quite a while now, since Dec 2008, is IAG.PR.A......on the recommendation we purchased 400 @ $12.55.......right now we're up almost 91% with an at cost div of 9.16%....4.8% at current price.)
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Re: Stupid question time: How to buy a "Preferred" share?

Post by kombat »

That's perfect, thanks guys, that's exactly what I was looking for. Now if I could just figure out how to specify to re-invest the dividends ... ;)
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Re: Stupid question time: How to buy a "Preferred" share?

Post by Descartes »

kombat wrote:Now if I could just figure out how to specify to re-invest the dividends ... ;)
This sounds like you want to set up a synthetic DRIP (dividend re-investment program). You can do this through your discount broker (at least you can for BMOInvestorline) for a select set of securities including some bank preferreds.
Call your broker or look through their web-site for how to set up a DRIP.
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Re: Stupid question time: How to buy a "Preferred" share?

Post by IdOp »

kombat wrote:I wish to do this within my RRSP ...
Note that income from preferred shares is usually treated as tax-advantaged dividend income, but if you hold them in a registered account this advantage will be lost.
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Re: Stupid question time: How to buy a "Preferred" share?

Post by Nortel'd »

kombat wrote:That's perfect, thanks guys, that's exactly what I was looking for. Now if I could just figure out how to specify to re-invest the dividends ... ;)
At RBC Investor's Edge my bank Preferred Share dividends are re-invested/dripped into the appropriate Common Stock.
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Re: Stupid question time: How to buy a "Preferred" share?

Post by CathyF »

I don't understand why people invest in preferred shares. For example, Royal Bank preferred shares (I picked "C" because it was mentioned earlier) gives about a 4.5% dividend. The common stock gives a 4% dividend.

So for a measly 0.5% more yield, you get:
- Virtually no upside in capital appreciation
- No chance of an increase in dividend
- You may NEVER have it come due! (Unlike a bond.) So you're stuck with the same dividend forever even when interest rates rise.
- You run the risk of the dividend being cancelled (just like the common stock), which would make the share almost worthless. (It's non-cumulative, so they never have to pay you back.)
- You run the risk of losing everything in bankruptcy. (I've never heard of a bankruptcy where the preferred shares had value after the common stock was wiped out. You're still ranked behind creditors, bond holders, pensions, employees, etc.)
- Poor liquidity of the shares
- No voting rights (okay, this may not be important unless you're betting on a take-out raising the price of the common stock)

I don't see why people buy preferred shares. I don't see they have any advantage over the common stock. If you want more security, buy the bonds (especially in an RSP).

That said, I understand there are some rule changes with banking that may make them likely to be redeemed in a few years. But as a general comment, I don't understand the interest in preferred shares. Even with cumulative preferreds, I doubt you'll ever see your money if they have to cut the dividend on them.
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Re: Stupid question time: How to buy a "Preferred" share?

Post by like_to_retire »

CathyF wrote:I don't understand why people invest in preferred shares. For example, Royal Bank preferred shares (I picked "C" because it was mentioned earlier) gives about a 4.5% dividend. The common stock gives a 4% dividend.
So for a measly 0.5% more yield, you get: - * Half a percent in fixed income is huge.

- Virtually no upside in capital appreciation - * Weigh this against the downside in capital depreciation of the common that the preferred share won't likely be subject to. Much less volatility in the pref.

- No chance of an increase in dividend - * And very, very, very unlikely that the dividend would ever be cut or reduced, as is not the case with the the common.

- You may NEVER have it come due! (Unlike a bond.) So you're stuck with the same dividend forever even when interest rates rise. - * Most bank shares are all considered deemed retractable due to OSFI's refusal to grandfather extant Tier 1 Capital which does not have an NVCC clause, so could be considered to enjoy maturity dates effective 2022-1-31.

- You run the risk of the dividend being cancelled (just like the common stock), which would make the share almost worthless. (It's non-cumulative, so they never have to pay you back.) - * the pref shares are senior to the common and are much less likely to have the dividend cancelled.

- You run the risk of losing everything in bankruptcy. (I've never heard of a bankruptcy where the preferred shares had value after the common stock was wiped out. You're still ranked behind creditors, bond holders, pensions, employees, etc.) - * fair enough, but the prefs are still senior to the common. Less risk with a higher dividend.

- Poor liquidity of the shares - * bank prefs enjoy sufficient volume. I see no problem in buying or selling at any time.

- No voting rights (okay, this may not be important unless you're betting on a take-out raising the price of the common stock) - * not important.

I don't see why people buy preferred shares. I don't see they have any advantage over the common stock. If you want more security, buy the bonds (especially in an RSP). - * people like preferred shares because they're another type of fixed income that's tax advantaged. Certainly nothing you would purchase in an RSP though.

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Re: Stupid question time: How to buy a "Preferred" share?

Post by Descartes »

CathyF wrote:I don't understand why people invest in preferred shares
1. Because it is relatively more secure than common:
a) capital protection - you don't have the same fluctuations in price as you do with commons (example: compare IAG with IAG.PR.A over the last 12 months)
b) dividend protection - the company must first cancel the common dividend before the preferreds can be touched (example: YLO and the various YLO preferreds)
2. Because it provides relatively better yield than equivalent bond and is eligible for dividend tax credit

With that said, I believe that many here are not buying at the current valuations and some are even reducing.
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Re: Stupid question time: How to buy a "Preferred" share?

Post by CathyF »

like_to_retire wrote:
CathyF wrote:I don't understand why people invest in preferred shares. For example, Royal Bank preferred shares (I picked "C" because it was mentioned earlier) gives about a 4.5% dividend. The common stock gives a 4% dividend.
So for a measly 0.5% more yield, you get: - * Half a percent in fixed income is huge.

I think you'd be better off going into slightly more risky bonds to get that half-percent, if it's that important. Besides, dividend increases over time in the common shares will more than compensate for that half-percent.


- Virtually no upside in capital appreciation - * Weigh this against the downside in capital depreciation of the common that the preferred share won't likely be subject to. Much less volatility in the pref.

Sure, but if you're buying for a steady income stream, you don't really care about the stock price until you go to sell, which should be many years away. Over that time, appreciation of stock price is far more likely than depreciation.

- No chance of an increase in dividend - * And very, very, very unlikely that the dividend would ever be cut or reduced, as is not the case with the the common.

Depends on the stock. I think if the banks were to cut their common dividend, then the preferred dividend wouldn't be far behind. I'm not sure what happened to the US banks that got into trouble. Did they ever eliminate their common dividend or pref? I may have to give this one to you in the extreme cases, but I still think the appreciation of the common dividend is much more likely than a reduction in it.

- You may NEVER have it come due! (Unlike a bond.) So you're stuck with the same dividend forever even when interest rates rise. - * Most bank shares are all considered deemed retractable due to OSFI's refusal to grandfather extant Tier 1 Capital which does not have an NVCC clause, so could be considered to enjoy maturity dates effective 2022-1-31.

Yes, I heard something about that. We'll have to see...

- You run the risk of the dividend being cancelled (just like the common stock), which would make the share almost worthless. (It's non-cumulative, so they never have to pay you back.) - * the pref shares are senior to the common and are much less likely to have the dividend cancelled.

Nortel, anyone? The prefs are worth about the same as the common stock now. i.e., zero. They suspended the pref dividend around the same time as the common. When that happened, I think you'd have been better off to own the common stock if you sold right away.

- You run the risk of losing everything in bankruptcy. (I've never heard of a bankruptcy where the preferred shares had value after the common stock was wiped out. You're still ranked behind creditors, bond holders, pensions, employees, etc.) - * fair enough, but the prefs are still senior to the common. Less risk with a higher dividend.

Again, I don't think it will matter. Equity holders of all kinds will be wiped out, otherwise the bond holders wouldn't force bankruptcy

- Poor liquidity of the shares - * bank prefs enjoy sufficient volume. I see no problem in buying or selling at any time.

Is that true during liquidity crunches like in 2008-2009? What were the buy-sell spreads, compared to the common stock?

- No voting rights (okay, this may not be important unless you're betting on a take-out raising the price of the common stock) - * not important.

Agreed, except for a take-over. Though that's probably unlikely for banks. (Nobody want to take over preferred shares, they take over common shares.)

I don't see why people buy preferred shares. I don't see they have any advantage over the common stock. If you want more security, buy the bonds (especially in an RSP). - * people like preferred shares because they're another type of fixed income that's tax advantaged. Certainly nothing you would purchase in an RSP though.

I can understand the tax advantage, though the common stock provides all the tax advantages in the dividend, plus tax advantages in capital gains (which you won't have much of with preferreds).
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Re: Stupid question time: How to buy a "Preferred" share?

Post by like_to_retire »

CathyF,

A lot of your argument is built around a company suffering a bankruptcy. This is not a likely occurrence with companies of highly rated preferred shares. More often you would see a reduction in a dividend of a common share when a company is hurting, while the pref share dividend is untouched (as it's not allowed).

To obtain the same after tax return from a bond of a company, the equivalency factor is approximately 1.3 compared to the preferred share. So a 5% return from a pref share is equivalent to a 6.5% bond with regard to after tax income. Hard to come by I'm afraid.

The volumes were quite large during the 2008 crisis. In fact, it was a particular sweet spot for preferred shares.

Anyway, we're comparing apples and oranges. There's a place for equities and a place for fixed income. Pref shares are a form of fixed income and deserve to be a part of that allocation. It has no effect on the equity allocation.

You wondered why people considered preferred shares. I offered some reasons.

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Re: Stupid question time: How to buy a "Preferred" share?

Post by CathyF »

like_to_retire wrote: A lot of your argument is built around a company suffering a bankruptcy. This is not a likely occurrence with companies of highly rated preferred shares. More often you would see a reduction in a dividend of a common share when a company is hurting, while the pref share dividend is untouched (as it's not allowed).
Yes, I realize that is possible, but how likely is it? Out of all the financial and utility companies in Canada, the only one I can think of that has slashed its common share and not touched prefs, is Manulife. Is it not far more likely that (1) the company will grow and raise the dividend of the common share, or (2) the company will suffer and be forced to cut all dividends? IMO, (1) is the most likely scenario, and hopefully is the case that even preferred shareholders are betting on. I doubt many pref buyers hope for a slash in the common dividend, as that likely puts their own holdings under pressure.
To obtain the same after tax return from a bond of a company, the equivalency factor is approximately 1.3 compared to the preferred share. So a 5% return from a pref share is equivalent to a 6.5% bond with regard to after tax income. Hard to come by I'm afraid.
In an after tax account, yes. Though I would presume people would place bonds in their RSP and equities outside of it. It also depends on income. As someone else pointed out in another thread, sometimes dividends can work against you, because of gross-up and OAS clawback.
The volumes were quite large during the 2008 crisis. In fact, it was a particular sweet spot for preferred shares.
I guess that's good. I may be misrembering things, but I thought that bank pref prices got hammered back then. I assumed it was because of poor liquidity, but I suppose it was for other reasons. In any case, I think it did demonstrate that preferred share prices can be volatile (though not as volatile as common stock).
Anyway, we're comparing apples and oranges. There's a place for equities and a place for fixed income. Pref shares are a form of fixed income and deserve to be a part of that allocation. It has no effect on the equity allocation.
Okay, I think this is at the heart of our disagreement. I don't consider preferred shares to be "fixed income". I consider them equity. In fact, they are equity, by definition. The way that some people treat them as fixed income I think is understating their risk.
You wondered why people considered preferred shares. I offered some reasons.
I see that. I'm just debating them. My "wondering" was more about opening up a debate on the issue, to discuss pros and cons. It wasn't just to get an answer then not be allowed to discuss.
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Re: Stupid question time: How to buy a "Preferred" share?

Post by westinvest »

While I would agree that preferred shares are equity, they act more like a hybrid of fixed income and equities. If you look at the example you used of RY and RY.PR.C, RY has a beta of .99 while RY.PR.C has a beta of about .11, and the TSX preferred index has a beta of about .19

Investors that are investing for income stability tend to prefer less volatility. Again, using the RY.PR.C example, the 4.5% yield is roughly equivalent to an interest income of close to 6%, to buy a corporate bond that yields 6% you would have to take on substantially more risk than that inherent in a bank preferred share.
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Re: Stupid question time: How to buy a "Preferred" share?

Post by Sensei »

Hi,

Interesting discussion. These comments aren't for or against prefs, but perhaps just other (maybe amateurish) reasons why I don't own any.* First, choosing a pref I've found, is not as simple an investment decision. Prefs are complicated investment vehicles and I assume that is why many people on FWR refer to Mr. Hymas before actually buying one. A preferred transaction generally guarantees the company gets $25 per share and the investor gets a pre-set dividend stream for a specific period of time, but with several stipulations attached to the transaction. To me, it is not as clear cut as a decision as to buy a common share or a bond.

Also, I have strong views on ownership. Recently, someone asked what a company gets by paying me a dividend. I replied that as a shareholder I am the company so it is my claim on ongoing profits. Preferred shareholders are not owners of the company as Cathy points out. This statement cuts much deeper than that it is simply a matter of a vote at a meeting (which few retail investors exercise anyway). Preferred shareholders have no stake in the ongoing successes of the company, meaning no increase in dividends. I'd go as far as to say that the price of the preferred on the open market has little to do with the health of the company. (Think feeding frenzy on preferreds for YLO as the ship sank.)

A common share implies that investors and the company are on the same side and indeed one and the same. We take the same risks. Preferred shareholders are third parties with interests that are often opposed to the company. Thus they stand to be disenfranchised at a time convenient to the company and most probably not so convenient for them.

On the other hand, common shareholders benefit from the rising fortunes of a company and the undeniable, if erratic, force of world economic growth. A common share guarantees a right to whatever profits a company makes in perpetuity. Dividends are, of course, important to me, but not a right. Yet, even after a dividend cut, I still have my shares. No one can take those away. Moreover, in the vast majority of cases, a company that is already paying dividends will continue to do so, and in the vast majority of cases, market crashes notwithstanding, dividends will increase in the long run, especially if it is over a diversified portfolio of dividend-paying stocks.

My choice, mostly, is to be with the company and therefore against market forces together as opposed to being in opposition to the company and its highly paid lawyers and accountants as well as against the market or at least neutral to it. There are a lot of ways to mess with preferred shareholders, thus the metric 'yield to worst'. Just as one example, as Mr. Hymas pointed out to me in response to an FWR question, with continuing low interest rates, companies will want to withdraw from preferred share obligations and reissue at lower rates (see RY below) or go elsewhere for their money. For any preferred sold on the open market you might want to look very,very closely at what you are buying.

Just looking at RY and RY.PR.A, RY.PR.A is trading above par with a 4.4% coupon. RY's yield is 4%. That would be the end of the decision for me. I'd buy the common in one of the world's strongest banks with S&P Quality and Credit Ratings in the As and healthy dividend raises in the last two years. For a preferred I'd be looking for at least +1% premium over the common dividend and a below par price. This at the very, very least.

Anyway, just some random thoughts.



*I do own PGX, a preferred share index fund in the US. The yield is 6.4% and it is more favorably taxed for me.
Last edited by Sensei on 13 Mar 2012 22:52, edited 2 times in total.
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Re: Stupid question time: How to buy a "Preferred" share?

Post by Peculiar_Investor »

Sensei wrote:Preferred shareholders are not owners of the company as Cathy points out.
I'm not sure I would agree with this statement. They have invested equity in the company, they just have a different class of shares, with different rights attached.

The shares are "preferred" because the dividends must be paid preferentially before any common stock dividends are paid. They may or may not have voting rights, depending on how the preferred shares have been defined.
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Re: Stupid question time: How to buy a "Preferred" share?

Post by schmuck »

like_to_retire wrote: The volumes were quite large during the 2008 crisis. In fact, it was a particular sweet spot for preferred shares.
ltr
Not so sweet for me.
Most perpetual bank prefs bottomed in Dec 08, down 40% for the year.
Many lifeco prefs were down 50% at the same time.
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Re: Stupid question time: How to buy a "Preferred" share?

Post by like_to_retire »

Many lifeco prefs were down 50% at the same time.
If a store has a 50% sale - is that not a good time to buy?

The beauty of that type of situation is the ability to create capital loses by swapping like issues, and the fact already mentioned that prefs don't reduce dividends when the share price dips.

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Re: Stupid question time: How to buy a "Preferred" share?

Post by Pickles »

schmuck wrote:
like_to_retire wrote: The volumes were quite large during the 2008 crisis. In fact, it was a particular sweet spot for preferred shares.
ltr
Not so sweet for me.
Most perpetual bank prefs bottomed in Dec 08, down 40% for the year.
Many lifeco prefs were down 50% at the same time.
That was when some of us bought. In my case, I had bought some financial prefs at par, or slightly above, in 2006/2007. I added to these in 2008, reducing my ACB to below par.

For 4 of my nine preferreds, I am getting more than 6% in dividends on the money I invested. On the others, over 5.5%. This is money that would otherwise have been invested in GICs where the highest rate I got during this period was 4.65%. I invest in prefs for income flow, not capital appreciation. With the dividend credit factor of 1.3, these prefs give me income equivalent of 7.8% return, compared to GICs.

The sweet spot worked for me; I also have significant capital appreciation on all my prefs (except the ylo pref which was a recent gamble). In the past year, I've sold three prefs above par which were vulnerable to a redemption at par. So far, only one has been redeemed. Time will tell whether I pulled the trigger too soon on the others.

in 2008, falling prices for prefs occurred because of general panic and lack of faith in financial institutions. The next fall in price will be because of rising interest rates and I will struggle to figure out whether to cash them in for the capital gain and reinvest or to continue to harvest the dividends and ignore their drop in market value.

In other posts on the subject, I've compared my pref portfolio to an annuity: both return an unchanging but steady income. With both, the return is tax-advantaged and larger than GICs (because of return of capital in the case of annuities). Of course an annuity is guaranteed for life and prefs are vulnerable to redemption -- even perpetual ones. Annuities are insured; prefs are not. But the income from a pref is not affected by one's age or gender. As a woman at the beginning of retirement, annuity rates are not appealing. But I have a need for steady income now. The prefs fill that gap.
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Re: Stupid question time: How to buy a "Preferred" share?

Post by CathyF »

like_to_retire wrote:
Many lifeco prefs were down 50% at the same time.
If a store has a 50% sale - is that not a good time to buy?

The beauty of that type of situation is the ability to create capital loses by swapping like issues, and the fact already mentioned that prefs don't reduce dividends when the share price dips.
That's an optimistic way of looking at it. :wink:


I can see there are some reasons to buy prefs. (Obviously there are, or there wouldn't be a market for them.) I just wonder if the retail investor is adequately considering the risk. (Do institutions even buy preferred shares?) It seems that many people compare them to guaranteed products, like GICs, and say what a great bargain they are. But they are very, very different products.

IMO, pref risk is much more closely compared to common share risk. They have all the downside risk of common shares, but very little upside (unless you buy them in a market crash on a gamble the company keeps paying out the dividends and recovers). Sure, the beta is very much reduced, but it's kind of an "all or nothing thing". i.e., very low volatility as long as the company remains solid, but will drop to zero if the company gets into trouble. (See Nortel example.)

To me, if I'm willing to take on that downside risk, I'd like to have the benefit of upside gain. The risk-adjusted returns of prefs just don't add up for me. I don't think beta adequately measures their risk.
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Re: Stupid question time: How to buy a "Preferred" share?

Post by like_to_retire »

Do institutions even buy preferred shares?
No, since they enjoy a tax exempt status, they choose bonds over prefs. As a result, pref shares are a retail product. This same reason is why no one should purchase pref shares in an RSP. The advantage is lost.

The fact that prefs are a retail product is a reason that they are more volatile than they should be, and this offers an opportunity to take advantage of goofy pricing (just ask James Hymas). More often than not, you will see two almost identical issues from the same company where one issue is priced much lower than the other. There's money to be made.
They have all the downside risk of common shares
No, the dividend will not be reduced with the preferred share - a huge difference. You should be far more worried if your income is derived from a portfolio of common shares than with a portfolio of preferred shares.

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Re: Stupid question time: How to buy a "Preferred" share?

Post by CathyF »

like_to_retire wrote:
They have all the downside risk of common shares
No, the dividend will not be reduced with the preferred share - a huge difference. You should be far more worried if your income is derived from a portfolio of common shares than with a portfolio of preferred shares.
I meant the downside risk is the same if the company files for CCAA, or gets close to doing so. I'm betting these prefs (both the cumulative and non-cumulative) aren't worth much right now, nor are they paying any dividends: http://www.prefblog.com/?p=3885
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Re: Stupid question time: How to buy a "Preferred" share?

Post by BRIAN5000 »

No, the dividend will not be reduced with the preferred share - a huge difference
Can you compare the top 6 banks common stock to their preferred's?

What is the chance of any of the top six banks of lowering their dividend? (yes the US banks did so what) So you have security of income stream.

If there is a chance of the common lowering their dividend are you not compensated for that risk (compared to a preferred) by a common shares potential for appreciation. In extreme conditions preferred share act the same way as equity shares. Yes you can load up on preferred's and earn a larger dividend and capital gains but how often will this happen. Once twice in a lifetime?
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Re: Stupid question time: How to buy a "Preferred" share?

Post by scomac »

If you insist on focusing on the extremes of downside risk -- IOW in CCRA both the common and preferred shares will ultimately be wiped out, then you need to also give some credit for the extremes that are possible to the upside. While there is a legitimate concern that there is little room for capital appreciation with preferred shares that trade at or in excess of par, you cannot completely discount the ability to earn significant capital gains over the fullness of business and interest rate cycles. As of Feb. 29/2012, the 10 CAGR of Malachite Aggressive Preferred Share Fund (James Hymas' retail fund offering) has been 12.3%. If you screen Canadian equity mutual funds on Globeinvestor for all funds with a RoR over 10 years that is comparable or better, you find none have matched this level of return.

If you want to focus on extremes with low probabilities of occurrence, then you must look at both extremes. You would be far better served to properly weigh the value of credit quality, interest rate risk, term risk and business risk before reaching a blanket conclusion that preferred shares are inferior to common shares, long corporate bonds or high yield debt. If you're going to reach for yield, you are always going to have to make a trade-off.
"On what principle is it, that when we see nothing but improvement behind us, we are to expect nothing but deterioration before us?"
Thomas Babington Macaulay in 1830
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