K. Le Du
The market prices of investments that have a known return do not
tend to bounce around as much as the market prices of alternatives
with lesser known returns. With a known return, the speculators -
those fairly certain that they know something that is unknown to
others - are removed from the market.
Preferred stocks, for example, tend to show less market price
volatility than common stocks for this very reason. In almost all
cases, preferred stocks pay a dividend of a known amount on a known
As intuitively obvious as this seems, we rarely have an
opportunity to directly measure it, but one such opportunity
presented itself during November.
In the aftermath of the November 6 elections, the S&P 500
Index of common stock prices fell by 5.25% (November 15) but has
gradually regained most of that loss over the subsequent weeks. By
plotting the movement of preferred stock market prices over the
same period, we have a rare opportunity to directly compare the
volatility of preferred stocks to common stocks in response to a
Over the last three weeks of November, the market prices of
preferred stocks, as reflected by the iShares US Preferred Stock
), followed the same pattern. But note how much less volatile the
market prices of preferred stocks were over this period. While
common stock prices dropped 5.25%, preferred stock prices fell less
than half of that amount (-2.08% on November 15).
Preferred Dividends Versus Common Dividends
Common stocks have shown no overall price appreciation over the
last thirteen years (with a couple of spectacular exceptions during
2003 and 2009). Similarly, preferred stock prices have been flat as
well but, as described above, for very different reasons .
Having little in the way of price appreciation to brag about
brings investors back to the dividend opportunity offered by these
two alternatives. And keep in mind that preferred stock
shareholders are always paid first before holders of the same
company's common stock, lowering the investor's risk.
Common stocks have paid an average annual dividend of about 2%
while preferred stocks are currently paying about 6% (about 1%
below their 7% long-term average).
Real Estate Investment Trusts (REITs) tend to be a bit more
generous. Take a look at this chart comparing the dividend yields
currently offered by REIT preferred stock versus the same company's
common stock dividend yield. Each diamond represents a specific
There are currently 42 high quality  preferred stocks trading
on U.S. stock exchanges issued by 14 REITs. In 11 out of these 14
cases, the company's preferred stocks are offering an annual
dividend yield that outpaces the same company's common stock yield
(as of November 30, 2012).
The three exceptions that you see above the Equal Yield Line are
PS Business Parks (
), Public Storage (
) and Hospitality Properties (
). In each of these three cases, the current yield being offered by
these companies' common stock dividend exceeds that available from
the average dividend yield of their preferred stock offerings.
Them's Fightin' Words
Given the choice between two alternative investments - one with
little price volatility, zero value appreciation but a current
average 6% annual dividend payout versus a second alternative that
has substantial price volatility, zero overall value appreciation
over the last thirteen years and an average 2% annual dividend
payout that you only receive after those who pick the first
alternative are paid in full, which would you choose?
As evidenced by the millions of common shares that trade every
day, there are certainly reasons that one would invest in common
stocks rather than preferreds, but overall price appreciation
performance, dividend payout and risk reduction do not appear to be
1. In addition to having a known return, another reason that
preferred stocks show less price volatility is due to their 'par'
value (usually $25 per share). This is the amount that a
shareholder will receive in the event that the issuing company
calls the security (buys the shares back from shareholders).
Since a preferred stock's par value is published in the
security's prospectus and is therefore known to investors,
preferred stock prices generally do not venture too far away,
especially if the market believes that a call is likely.
2. "High quality" preferred stocks are those that meet the
ten preferred stock selection criteria itemized in my book,
Preferred Stock Investing (such as having cumulative dividends
and investment grade ratings).
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
Securities identified within this article are for illustration
purposes only and are not to be taken are recommendations.
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